-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, A52GQWS1Mwwi+HrmrN4TKGsMQ+LXsj4gwma3tEOBkgQcFcC674piNj+NfkwU7+p5 GcnD2FopDIwW+dvo23SHAg== 0000950109-98-002322.txt : 19980401 0000950109-98-002322.hdr.sgml : 19980401 ACCESSION NUMBER: 0000950109-98-002322 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 12 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980331 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: SYLVAN LEARNING SYSTEMS INC CENTRAL INDEX KEY: 0000912766 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-EDUCATIONAL SERVICES [8200] IRS NUMBER: 521492296 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-22844 FILM NUMBER: 98580438 BUSINESS ADDRESS: STREET 1: 1000 LANCASTER ST CITY: BALTIMORE STATE: MD ZIP: 21202 BUSINESS PHONE: 4108438000 MAIL ADDRESS: STREET 1: 1000 LANCASTER ST CITY: BALTIMORE STATE: MD ZIP: 21202 10-K 1 FORM 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [X] Annual Report pursuant to Section 13 or 15(d) of the Securities and Exchange Act of 1934 for the fiscal year ended DECEMBER 31, 1997 ----------------- or [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from __________ to __________. COMMISSION FILE NUMBER 0-22844 ----------- SYLVAN LEARNING SYSTEMS, INC. ----------------------------- (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) Maryland 52-1492296 - --------------------------------------------- ------------------------ (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 1000 LANCASTER STREET, BALTIMORE, MARYLAND 21202 - --------------------------------------------- ------------------------ (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (410)843-8000 --------------- SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NAME OF EACH EXCHANGE ON TITLE OF EACH CLASS WHICH REGISTERED - --------------------------------------------- ------------------------ COMMON STOCK, PAR VALUE $.01 NASDAQ SECURITIES REGISTERED PURSUANT TO THE SECTION 12(g) OF THE ACT: NONE ------ Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X]. No [ ]. Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of voting Common Stock held by non-affiliates of the registrant was approximately $1.2 billion as of March 17, 1998. The registrant had 29,670,910 shares of Common Stock outstanding as of March 17, 1998. DOCUMENTS INCORPORATED BY REFERENCE ----------------------------------- Certain information in Sylvan Learning Systems, Inc.'s definitive Proxy Statement for its 1998 Annual Meeting of Shareholders, which will be filed with the Securities and Exchange Commission pursuant to Regulation 14A no later than April 30, 1998 is incorporated by reference in Part III of this Form 10-K. 1 INDEX -----
PAGE NO. -------- PART I. Item 1. Business............................................. 3 Item 2. Properties........................................... 10 Item 3. Legal Proceedings.................................... 10 Item 4. Submission of Matters to a Vote of Security Holders.. 10 PART II. Item 5. Market for Registrant's Common Equity and Related Stockholder Matters............. 11 Item 6. Selected Financial Data.............................. 11 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations...... 16 Item 8. Financial Statements and Supplementary Data.......... 23 Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure............. 23 PART III. Items 10., 11., 12. and 13. are incorporated by reference from Sylvan Learning Systems, Inc.'s definitive Proxy Statement which will be filed with the Securities and Exchange Commission, pursuant to Regulation 14A, not later than April 30, 1998........................ 24 PART IV. Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K............................ 24 SIGNATURES
2 PART I. ------ ITEM 1. BUSINESS Sylvan Learning Systems, Inc. ("the Company" or "Sylvan") is the leading provider of educational services to families, schools and industry. The Company provides lifelong educational services through three lines of business: the Sylvan Prometric division delivers computer-based testing for academic admissions and professional certification programs, and includes the operations of Wall Street Institute, a European based franchisor and operator of learning centers for English language instruction that will also administer certain computer-based testing programs throughout Europe and Latin America; the Sylvan Learning Centers division provides personalized instructional services to students of all ages and skill levels and the Sylvan Contract Educational Services division provides educational services and professional development through contracts with school systems and other organizations. Sylvan's services are delivered through its network of more than 3,000 educational and testing centers around the globe. In 1997, total system-wide revenues were approximately $395.5 million, composed of $193.6 million from core educational services ($162.4 million from franchised Learning Centers and $31.2 million from Company-owned Learning Centers, product sales, franchise sales fees and other franchise service revenues), $135.3 million from testing services and $66.6 million from contract educational services. Note 21 of the 1997 audited financial statements contains additional disclosures regarding the Company's business and geographic segments. CORE EDUCATIONAL SERVICES: SYLVAN LEARNING CENTERS Sylvan is widely recognized as providing high quality educational services with consistent, quantifiable results, and has delivered its core educational service to more than 1.1 million students primarily in grades three through eight over the past 18 years. The Company's core educational service segment provides supplemental instruction in reading, mathematics and reading readiness, featuring an extensive series of standardized diagnostic tests, individualized instruction, a student motivational system and continued involvement from both parents and the child's regular school teacher. Typically, a parent contacts a Sylvan Learning Center because the parent believes that his or her child may have insufficient reading or mathematics skills. Parents learn about Sylvan from the Company's media advertising, from a referral from another parent or from school personnel. Learning Center personnel ask the parent to bring the student to the Learning Center to complete a series of standardized diagnostic tests and to receive educational consultation. Approximately 35% of phone inquiries result in a visit to a Learning Center. The Learning Center's Sylvan-trained educators use test results to diagnose students' weaknesses and to design an individual learning program for each student. After the initial testing and consultation, the Company estimates that more than 90% of parents enroll the student in a full course of study. The program typically requires four to six months to complete and comprises approximately 36 to 60 hours of instruction. Instruction is generally given twice a week for one hour per visit. Sylvan requires that all instructors be certified teachers. The cost of the tests and initial consultation ranges from $95 to $250, and fees average $35 per hour. The Company estimates that the typical program costs approximately $1,500. Learning Centers range from 1,000 to 3,500 square feet. Instruction is given at U-shaped tables designed to ensure that teachers work with no more than three students at a time. The student's individualized one hour lesson includes a five segment mastery approach. There are special incentives, such as tokens redeemable for novelties and toys, to motivate the student to achieve the program's objectives and to strengthen the student's enthusiasm for learning. Personal computers at each Learning Center are used by the student as a supplemental learning tool. The Learning Center's Director of Education monitors the progress of each student after each hour of instruction. Instructors schedule parent conferences after every 12 hours of a student's program. Throughout a student's course of study, the Learning Center tests the student using the same standardized diagnostic tests, and the results are shared with the parents in personal conferences, during which the student's continuation in a Sylvan program is discussed. Franchise Operations. As of December 31, 1997, there were a total of 670 Learning Centers in 49 states, five 3 Canadian provinces, Hong Kong, South Korea and Guam operated by the Company or its franchisees. As of that date, there were 460 franchisees operating 622 Sylvan Learning Centers. During 1997, 60 franchised Learning Centers were opened and five were closed. In addition, during 1997, 13 franchisee-owned Learning Centers were acquired by the Company. Fewer than 2% of franchisees are currently more than three months in arrears in the payment of franchise royalties, and the Company does not believe that the closing of any or all of the Learning Centers of these franchisees would have a material adverse effect on the Company because the royalties earned from these franchisees only represented approximately 1% of total franchise royalties earned by the Company in 1997. The Company licenses franchisees to operate Sylvan Learning Centers in a specified territory, the size of which depends on the number of school-age children and average household incomes in the area. Franchisees must obtain the Company's approval for the location and design of the Learning Center and of all advertising, and must operate the Learning Center in accordance with the Company's methods, standards and specifications. Most Learning Centers are located in suburban areas and have approximately 10 employees, two of which are typically full-time employees and eight of which are part-time instructors. The cost to open a typical franchised Learning Center ranges from approximately $79,000 to $145,000, including the franchise license fee, furniture, equipment and an initial supply of certain items required under the Company's franchise agreement. The Company actively manages its franchise system. The Company requires franchisees and their employees to attend two weeks of initial training in Learning Center operations and Sylvan's educational programs. The Company also offers franchisees continuing training each year. The Company employs field operations managers that act as "consultants" to provide assistance to franchisees in technology implementation, business development, marketing, education and operations. These employees also facilitate regular communications between franchisees and the Company. Sylvan operates a quality assurance review program to maintain the quality of Sylvan Learning Centers. Sylvan's field operations managers confirm franchisee compliance with the Company's standards, including training requirements, exclusive use of approved educational materials and programs, correct administration of testing materials, proper execution of supervisory procedures, sufficient time spent in parent/teacher conferences, staffing and Learning Center appearance. Sylvan's field managers counsel franchisees that fail to meet the Company's quality or financial performance standards and assist these franchisees in developing a plan to improve their Learning Centers' performance. When necessary, the Company assists franchisees in selling their franchises. The Company believes there is significant potential for additional franchised Learning Centers both domestically and internationally. A number of territories with only one Learning Center could support one or more additional Learning Centers based upon the number of school-age children in the market area. The Company is actively encouraging existing franchisees in these territories to open additional Learning Centers. In addition, management has identified at least 234 territories in North America, primarily in smaller markets, in which there are no Learning Centers. The Company is actively seeking franchisees for a number of these territories. Forty-two new territories were sold in 1997. The Company has sold franchise rights for the operation of Learning Centers in South Korea, Hong Kong, China, the United Kingdom, Spain and the Philippines. In pricing international franchise rights, the Company takes into account estimates of the number of centers that could be opened in an area. The Company's typical franchise agreement (the "License Agreement") grants a license to operate a Sylvan Learning Center and to use Sylvan's trademarks within a specified territory. The franchisee is required to purchase from Sylvan certain diagnostic and instructional materials, student record forms, parental information booklets and explanatory and promotional brochures developed by the Company. Sylvan specifies requirements for other items necessary for operation of a Learning Center, such as computers, instructional materials and furniture. The Company currently offers a License Agreement with an initial term of ten years, subject to unlimited additional ten year extensions at the franchisee's option on the same terms and conditions. The initial license fee ranges from $34,000 to $42,000, depending on factors such as the number of school-age children in the territory. Royalties are either 8% or 9% of gross revenues of the Learning Center, and the royalty rate depends upon the demographics of the territory and is specified in the License Agreement. Advertising spending requirements range from $1,000 to $3,500 per month, or up to 6% of gross revenues, whichever is greater. The License Agreement has been revised periodically, and several franchisees are operating under older agreements with variations from the above terms. Approximately 10% of 4 franchisees operate under older agreements with royalties as low as 6% and without any requirement to contribute to the national advertising fund. The remaining 90% of the franchisees are required to contribute a minimum of 1.0% to 1.5% of gross revenues to the national advertising fund. The fund is administered by the SLC National Advertising Fund, Inc. ("SNAF"). The Franchise Owners Association ("FOA") owns the SNAF. The FOA is an association whose members consist of Sylvan franchise owners. Franchisees must submit monthly financial data to the Company. Company-owned Learning Centers. As of December 31, 1997, Sylvan owned and operated 48 Learning Centers: five in Baltimore, seven in Dallas, six in Los Angeles, five in Orange County, California, six in the greater Philadelphia area, six in South Florida, eight in the greater Washington, D.C. area and five in the greater Minneapolis area. The Company's operation of Learning Centers enables it to test new educational programs, marketing plans and Learning Center management procedures. As of December 31, 1997, eleven of the Company-owned Learning Centers contained Technology Centers for computer-based testing. Company-owned Learning Centers give the Company a local presence in key markets, which has been helpful in marketing the Company's services to school districts utilizing Title I funds and to employers interested in the Sylvan-At-Work and PACE programs (see "Contract Educational Services" on page 7). The Company may consider selected acquisitions of additional Learning Centers now operated by franchisees. SYLVAN PROMETRIC The Company conducts its testing business through 1,981 testing centers, 1,125 of which are located in the United States and Canada and the remainder of which are located in 103 foreign countries. These centers are classified as either Sylvan Technology Centers ("STCs") or Authorized Prometric Testing Centers ("APTCs"). STCs are generally located in certain existing franchisee and Company-owned and operated sites. During 1997, the Company added 691 testing centers, of which 617 were APTCs. The Company believes that it can increase capacity by adding workstations at existing testing centers, as well as by opening new testing centers. Opening a new testing center can take up to 120 days. Computer-based tests, which can be offered during regular school hours and on weekends at STCs, increase the utilization of Learning Centers. Testing also increases the public awareness of Sylvan Learning Centers and the Company's core educational services. For STCs, Sylvan provides the supporting infrastructure and administration, including computer equipment and software systems in each testing center and where appropriate, registration and scheduling of candidates, downloading of individual tests and training and certification of STC personnel in accordance with procedures established by the sponsoring testing organization. The franchisee provides the space and staffing for the testing center. The Company enters into contracts directly with the testing organization, such as Educational Testing Service ("ETS"), under which Sylvan receives a fee based upon the number of tests given. The Company has entered into a separate agreement with each franchisee that operates a testing center, whereby the franchisee receives a fee per test that decreases as the volume of the tests delivered increases. APTCs must meet certain criteria established by the Company for administering computer-based testing and are required to furnish the space, equipment and personnel needed for their operation and receive compensation for test delivery in various forms including marketing assistance for their core business. Principal customers in the information technology ("IT") industry are Microsoft Corporation and Novell, Inc.. IT customers sponsor worldwide certification programs for various professionals such as network administrators and engineers, service technicians, instructors, application specialists and developers, and system administrators, operators and engineers. Certification testing for Microsoft and Novell accounted for $39.3 million, or 29%, of Sylvan Prometric's revenues in fiscal 1997. ETS, a leading educational testing firm, develops and administers more than 9.0 million tests each year, including the Graduate Record Exam ("GRE"), the Graduate Management Admissions Test ("GMAT"), The Test of English as a Foreign Language ("TOEFL"), the National Teachers Exam ("NTE") and the Advanced Placement Program, sponsored by organizations such as the College Board. The largest tests administered by ETS are the SAT, of which 2.3 million are given annually to college-bound students, and the PSAT, of which 1.9 million are given annually to all students in grade 10 or 11. As one of the largest and most influential test developers and administrators, ETS is leading the conversion of tests to computer-based format from pencil and paper versions. The Company developed a working relationship with ETS as a result of a joint venture between ETS and a 5 predecessor of the Company in the late 1980s. This relationship facilitated the Company's entering into a master agreement with ETS (the "ETS Agreement"), under which the Company is the exclusive commercial provider of computer-based tests administered by ETS. This exclusivity provision does not apply to the SAT, PSAT and Achievement Tests that are sponsored by the College Board. During 1997, the Company recognized approximately $33.2 million, or 25% of Sylvan Prometric's revenues in fiscal 1997, from services for ETS. The Company provides testing services through two contracts with ETS to provide services both in North America and internationally. Sylvan initially signed a contract for computer-based test delivery in North America in 1993 with a term expiring in 1999. This North American contract was renegotiated in 1997 and now extends through 2005. The North American contract continues to provide that Sylvan will be ETS's exclusive commercial provider of computer-based testing services in North America, provided Sylvan can provide sufficient capacity to meet candidate testing demand, in accordance with the criteria set forth in the contract. Further, the contract provides that the Company will deliver not less than 50% of ETS's computer-based testing volume (excluding College Board tests) in North America. The North American contract also provides that ETS may establish computer- based test sites (subject to the requirement for 50% of the computer-based testing volume being delivered by the Company) at three specific ETS locations, at ETS client specific locations and at test centers located in colleges, universities and similar institutions. At present, there are approximately 40 ETS operated test sites. ETS and the Company entered into an international contract for delivery of ETS computer-based tests in 1994. The terms of the contract stipulate that the Company will be compensated for its services through a fee equal to approved costs, plus 10 percent, and the Company recognizes revenue accordingly. The Company also is reimbursed for its cost of capital and any foreign exchange losses. During 1997, the Company recognized revenues of approximately $17.7 million under this contract. In return for the cost plus compensation, the Company is required to establish a network of international computer-based testing sites and to deliver ETS's computer-based tests. The contract provides that the Company shall be the exclusive provider of computerized commercial testing capacity to ETS for all secure testing programs outside North America. ETS may establish its own test sites only where Sylvan fails to provide sufficient capacity as defined by the contract or where the Company's costs of providing the service would be prohibitive. There are no ETS sites for computer- based testing operated internationally. During 1997, the Company expanded international testing for ETS to a total of 116 permanent and 30 temporary sites in 79 countries. Under the ETS agreements, the Company offers computer-based versions of ETS' PRAXIS examination, which is used to license beginning teachers, the GRE, which is used by graduate schools to evaluate applicants, and through a contract with the National Council of State Boards of Nursing, a computer-based licensing examination (NCLEX) for registered and practical nurses. In October 1997, Sylvan and ETS converted the GMAT examination to computer-based delivery on a world-wide basis. In addition to the tests offered through its partnership with ETS, the Company is one of three entities licensed by the FAA to deliver computer-based versions of various pilot and mechanical licensing tests for private aviation. In addition to FAA testing, the Company provides testing services for organizations in many other fields, such as for computer professionals, medical laboratory technicians and military candidates. The Company, in December 1996, purchased Wall Street Institute International, B.V. and it's commonly controlled affiliates (collectively, "WSI"), a European based franchisor and operator of learning centers where English is taught through a combination of computer-based and live instruction. Typically, the instructional programs are approximately nine months to one year in duration. WSI has more than 200 company-owned and franchised centers in operation throughout Europe and Latin America. The 1996 acquisition of WSI is an important step in Sylvan's strategy to increase its services to the adult education marketplace and to expand internationally. Sylvan began building a global network for the delivery of computer-based testing services in early 1994 through an exclusive international alliance with ETS. In addition to offering the English language programs, WSI locations will be utilized by Sylvan to administer certain computer-based testing programs throughout Europe and Latin America, and accordingly is considered part of the Company's Sylvan Prometric testing division. 6 WSI has 82 centers in Spain with the remainder in France, Germany, Italy, Portugal, Switzerland, Mexico, Chile, and Venezuela. WSI's international expansion was accomplished by selling Master Licensing agreements, with each Master Licensor obtaining franchisees to open centers in their development areas. Sylvan plans to continue this strategy to expand WSI's presence globally, with a focus on the Middle East, Africa and the Pacific Rim region. Effective December 1, 1997, the Company purchased Block Testing Services L.P., Block State Testing Services L.P. and National Assessment Institute, Inc., (collectively "NAI/Block"), commonly-controlled companies engaged in the business of designing, marketing, selling, distributing and administering paper and pencil tests for the licensing of individuals. NAI/Block operates 12 regional offices that develop and administer licensing examinations on the state, county and local municipality level for various industries, including but not limited to the construction, cosmetology, real estate and medical industries. These 12 regional offices provide examinations for 41 states, the District of Columbia and the Virgin Islands. With the acquisition of NAI/Block, the Company is now providing services to a market that it had not previously serviced. CONTRACT EDUCATIONAL SERVICES: PUBLIC AND NON-PUBLIC SCHOOL BASED PROGRAMS FUNDED BY FEDERAL TITLE I AND STATE-BASED PROGRAMS; EDUCATIONAL INROADS, PACE AND SYLVAN-AT-WORK Title I and state-based programs. The federal government and various state and local governmental agencies allocate funds to local school districts to provide supplemental remedial education to academically and economically disadvantaged students. The main program is the Title I (formerly Chapter I) program, administered by the U.S. Department of Education. Federal law now contains minimum student performance standards for each school district receiving Title I funds. The Company believes that because of its proven record of achieving measurable improvement in the reading and mathematics skills of its students nationwide, it is positioned to provide supplemental educational services to school districts receiving Title I and similar state funds. As of December 31, 1997, the Company had contracts to provide supplemental remedial educational services to the following public schools: 45 Baltimore schools, 12 Chicago schools, 10 Detroit schools, eight Washington D.C. schools, five St. Paul schools, four Richmond schools and 25 schools in twelve other school districts. In January 1998, the Company was awarded a contract to provide supplemental remedial education services in eight public schools in the district of Compton, California. Using Company personnel, Sylvan offers virtually the same core educational services to students in schools as is offered at Sylvan Learning Centers. The school designates a classroom to be the Learning Center for the duration of the contract and modifies the classroom to resemble a typical Learning Center. Sylvan personnel administer standardized diagnostic tests and, based on the results, prescribe an individualized learning program for each child. Students typically receive two hours of instruction per week, which includes the use of personal computers as in a Learning Center. The Company can provide these services to students after school, on Saturdays, during the summer or as a "pullout" program during the regular school day, which is the method currently prescribed by most current contracts. There is a high degree of individual attention, with student to teacher ratios of no more than three to one. The program is designed to include a high degree of parental involvement, and teachers make a special effort to have the parents involved. Under most of its contracts, the Company has guaranteed that each student who receives instruction in the Sylvan program and meets prescribed attendance requirements will achieve some minimum measure of improvement required by the school districts, as measured by standardized tests. Improvement is measured using various standardized measures, including normal curve equivalents ("NCE's") a generally accepted statistical measure of student performance. The typical minimum improvement required is two NCE's per year. If a student does not achieve the required improvement, the Company will provide 12 hours of remedial instruction to that student during the following summer or school year without charge. The Company has not incurred significant expense related to this guarantee. Under the contracts, the school districts pay the Company a set fee for all services, materials and equipment. The contracts have terms of one to three years, with the latest expiring in June 2001. All of the contracts contain provisions for cancellation by school district officials based on funding constraints. The Company is actively seeking contracts to provide its core educational program to other school systems, offering to tailor its program to the system's specific needs, and is in discussions with several other major school districts. In addition to serving public school students, Sylvan can provide its service to parochial or private school 7 students through contracts with public school districts. Public school districts are responsible for administering the Title I funding for the non-public schools. Because government-funded services to any parochial school students generally cannot legally be provided in the parochial school, Sylvan offers the flexibility of conducting the program at a nearby Learning Center, or providing temporary facilities. Educational Inroads. On May 30, 1997 the Company acquired by merger all of the outstanding stock of I-R, Inc. and Independent Child Study Teams, Inc. (collectively, "Educational Inroads") in exchange for 1,414,000 shares of common stock. I-R, Inc. and Independent Child Study Teams, Inc. were commonly owned by two shareholders. Educational Inroads provides remedial and special education services to public and non-public school systems, with current contracts in New Jersey, Maryland, Louisiana, Washington D.C. and other school districts. PACE. In March 1995, the Company acquired The PACE Group ("PACE"), a provider of educational and training services to large corporations throughout the United States. Services offered by PACE include racial and gender workplace diversity training and skills improvement programs such as writing, advanced reading, listening and public speaking. This acquisition compliments the Company's Sylvan-At-Work program and extends the core educational services the Company offers to adults in the corporate workplace. PACE provides educational and training services, typically on-site, to businesses throughout the United States and generated $15.6 million in revenues for the year ended December 31, 1997. Management believes PACE is capitalizing on the trend toward outsourcing of training services by large corporations. PACE licenses most of these programs from the individuals who developed them and pays royalties ranging from 5% to 15% of the revenues generated from the programs. These programs are typically offered on-site from one to several days at a time and are conducted by trained instructors employed by PACE, or, in some cases, PACE will train the customer's employees to conduct the programs. Additionally, a corporation may purchase a site license to offer a particular PACE program. PACE currently has 26 sales offices throughout the United States and markets the programs locally through its sales force. PACE customers include Ford Motor Company, IBM, BankOne, General Motors and AT&T. Sylvan-At-Work. The Company's Sylvan-At-Work program is a modified version of Sylvan's core educational service provided to businesses on-site. Programs are currently offered for Motorola, Inc., at one site in Austin, Texas; for Texas Instruments Incorporated, at three sites in the Dallas area; and for Lockheed Martin Energy Systems, Inc., at one site in Tennessee. The Canter Group. In January 1998, the Company acquired Canter and Associates, Inc. and Canter Educational Productions, Inc. (collectively, "The Canter Group" or "Canter"), a leading provider of training, staff development and graduate courseware for educators. The Canter Group had revenues of approximately $20.0 million in 1997. This acquisition will allow Sylvan to continue to expand into the college and university market with a proven course curriculum. MARKETING The Company and its franchisees market Sylvan's core educational service to parents of school-aged children at all grade levels and academic abilities. Far beyond tutoring, Sylvan Learning Centers' supplemental education utilizes a diagnostic and prescriptive approach to address the specific needs of each and every student. A portion of Sylvan's advertising includes spots on morning and evening news on the national networks. Sylvan's advertising campaign demonstrates the benefits of its personalized educational services through testimonials of actual parents and Sylvan teachers. It positions Sylvan as the leader in supplemental education and emphasizes Sylvan's high quality curriculum, personalized attention and positive results: better grades and improved self-esteem. Franchisees form local cooperatives to collectively purchase local television and radio advertising and usually supplement their efforts with local newspaper and direct mail. The company also has additional marketing support for specific programs, including Reading, Math, Algebra, Geometry, Study Skills, SAT/ACT College Prep, and Writing. The Company is actively involved in marketing computer-based testing services to national and international academic testing organizations, such as ETS, and licensing and professional certification organizations. The Company's network of testing centers, centralized registration capability and computer-based testing experience offers important competitive advantages. The Company markets its school-based educational services to several public school systems and state education departments. This marketing effort has been expanded to seek contracts for both public and non-public schools, where both are administered by the local public school district. 8 Marketing efforts for the PACE programs are focused on large corporations seeking to outsource their training and educational programs, through PACE's 26 sales offices throughout the United States. PACE's strategy is to offer solutions to the customer's training needs rather than marketing specific products. COMPETITION The Company is aware of only two direct national corporate competitors in its core educational services segment: Huntington Learning Centers, Inc. and Kumon Educational Institute. The Company believes these competitors operate fewer centers than Sylvan and that these firms concentrate their services within a smaller geographic area. In most areas served by Sylvan Learning Centers, the primary competition is from individual tutors. State and local education agencies also fund tutoring by individuals, which competes with the Company's core educational services segment. The Company's contract educational services segment's most significant competitor remains the public school system itself. Given the unique position of public education in the United States, the Company believes that educational reforms implemented directly by school officials will not face the same degree of public resistance that the Company may face. The Company also competes with school reform efforts sponsored by private organizations and universities and with consultants hired by school districts to provide assistance in the identification of problems and implementation of solutions. The Company is aware of several entities that currently provide Title I and state-based programs for students attending parochial and private schools on a contract basis. Sylvan Prometric also has a small number of direct competitors. These competitors include organizations that have opened centers to offer specific computer-based tests under contracts with the administrators of those tests. GOVERNMENT REGULATION Title I. Title I school districts are responsible for implementing Title I in carrying out their educational programs. Title I regulations, as well as provisions of Title I itself, direct Title I school districts to satisfy obligations including involving parents in their children's education, evaluating and reporting on student progress, providing equitable services and other benefits to eligible non-public school students in the district and other programmatic and fiscal requirements. In contracting with school districts to provide Title I services, the Company has become and will continue to be, subject to various Title I requirements and may become responsible to the school district for carrying out specific functions required by law. For example, under the Baltimore City Schools' contract, Sylvan has responsibility for soliciting parental involvement, introducing program content adequate to achieve certain educational gains and maintaining the confidentiality of student records. The Company's failure to adhere to Title I requirements or to carry out regulatory responsibilities undertaken by contract may result in contract termination, financial liability, or other sanctions. Franchise. The sales of franchises are regulated by various state authorities as well as the Federal Trade Commission (the "FTC"). The FTC requires that franchisors make extensive disclosure to prospective franchisees but does not require registration. A number of states require registration and prior approval of the franchise offering document. In addition, several states have "franchise relationship laws" or "business opportunity laws" that limit the ability of a franchisor to terminate franchise agreements or to withhold consent to the renewal or transfer of these agreements. While the Company's franchising operations have not been materially adversely affected by such existing regulation, the Company cannot predict the effect of any future legislation or regulation. Trademarks The Company has a federal trademark registration for the words "Sylvan Learning Center" and distinctive logo (a reading child), a service mark for the words "Sylvan Prometric" and various other trademarks and service marks and has applications pending for a number of other distinctive phrases. The Company also has obtained foreign registrations of a number of the same trademarks. The Company's License Agreement grants the franchisee the right to use the Company's trademarks in connection with operation of the franchisee's Learning Center. 9 EMPLOYEES As of December 31, 1997, the Company had approximately 3,600 employees, 2,000 of whom were classified as full-time and 1,600 of whom were classified as part- time. Most of the Company's part-time employees are teachers in school-based programs, Company-owned Learning Centers and Sylvan-At-Work programs. None of the Company's employees are represented by a union and the Company considers its relationship with its employees to be good. EFFECT OF ENVIRONMENTAL LAWS The Company is in compliance with all environmental laws. Future compliance with environmental laws is not expected to have a material effect on the business. ITEM 2. PROPERTIES The Company leases all of its facilities, consisting principally of administrative office space and Learning Centers and testing sites. The Company leases approximately 108,000 square feet of space in Baltimore, Maryland for its administrative offices. In addition, the Company leases approximately 55,000 square feet in Minneapolis, Minnesota for general office space and a registration center, 27,000 square feet in Woodlawn, Maryland for a registration center and 14,600 square feet in Baltimore, Maryland for a Logistics Center. The Company also leases space for the 48 Company-owned Learning Centers in Maryland, Texas, California, Pennsylvania, Delaware, New Jersey, Florida, Minnesota and Virginia, ranging from 1,500 to 3,500 square feet per Learning Center. The Company also leases space for 80 testing centers in areas where there is no Learning Center franchise. These spaces range from 500 to 3,500 square feet. The Company leases space for 54 international testing sites ranging from 500 to 5,000 square feet, with the lease terms from three to five years. ITEM 3. LEGAL PROCEEDINGS From time to time, the Company may be a party to routine litigation incidental to its business. At this time, the Company is the defendant in a legal proceeding pending in the United States District Court for the Northern District of Iowa, Civil Action No. C96-334MJM, filed on November 18, 1996 by ACT, Inc., an Iowa nonprofit corporation formerly known as American College Testing Program, Inc. ("ACT"). ACT's claim arises out of the Company's purchase of contract rights to administer testing services for the National Association of Securities Dealers, Inc. ("NASD"). ACT has asserted that the Company tortuously interfered with ACT's relations, contractual and quasi-contractual, with the NASD, caused ACT to suffer the loss of its advantageous economic prospects with the NASD and other ACT clients and that the Company has monopolized and attempted to monopolize the computer-based testing services market. ACT has claimed unspecified amounts of compensatory, treble and punitive damages, as well as injunctive relief. The Company believes that all of ACT's claims are without merit. At this time the Company is not a party, either as plaintiff or defendant, in any other material litigation. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter ended December 31, 1997. 10 PART II. -------- ITEM 5. MARKET FOR REGISTRANTS'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock has traded on the NASDAQ Stock Market since its initial public offering on December 9, 1993. The Company's trading symbol is SLVN. The high and low trade prices for 1996 and 1997 for the Company's common stock are set out in the following table. These prices are as reported by NASDAQ, and reflect inter-dealer price quotations, without retail mark-up, mark down or commission and may not necessarily represent actual transactions. 1996 High Low --------------- ------ ------ 1st Quarter $26.17 $18.00 2nd Quarter $27.50 $21.33 3rd Quarter $27.50 $18.67 4th Quarter $33.00 $24.25 1997 High Low --------------- ------ ------ 1st Quarter $37.75 $24.25 2nd Quarter $37.38 $23.88 3rd Quarter $44.50 $32.75 4th Quarter $46.25 $38.00 No dividends were declared on the Company's Common Stock during the years ended December 31, 1996 and 1997, and the Company does not anticipate paying dividends in the future. The number of registered shareholders of record as of March 17,1998 was 326. During the year ended December 31, 1997, the Company issued 1,104,104 shares of its common stock that were not registered under the Securities Act of 1933. On January 28, 1997, the Company issued 434,340 shares to Dr. Luigi T. Peccenini pursuant to the acquisition of WSI. On February 3, 1997, the Company issued 39,552 shares to Carter Holdings, Inc. for the purchase of six franchised learning centers. On June 30, 1997, the Company issued 214,000 shares to Sylvan Learning Foundation as a charitable contribution. On June 30, 1997, the Company contributed 205,882 shares to IT Training Marketing Company. On June 30, 1997, the Company contributed 149,059 shares to SLC National Advertising Fund, Inc. On September 30, 1997, the Company issued 2,450 shares to Harold A. Sakayan for the purchase of one franchised learning center. On September 30, 1997, the Company issued 15,557 shares to the shareholders of PMZ Inc. for the purchase of nine franchised learning centers. On December 10, 1997, the Company issued 21,632 shares to Ralph Celidonio and 21,632 shares to Vince Donohue for the purchase of a business. ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA On February 1, 1991, Sylvan Learning Corporation (a predecessor to the Company) and KEE, Incorporated ("KEE"), a computer training software development business owned by a group of investors including Messrs. Hoehn-Saric and Becker, the Co-CEOs of Sylvan, entered into a joint venture by contributing substantially all of their assets to Sylvan KEE Systems, a Maryland general partnership (the "Partnership"), each in exchange for a 50% interest in the Partnership. Messrs. Hoehn-Saric and Becker assumed management responsibility for the Partnership. The Partnership operated the business through January 26, 1993, when KEE purchased all of Sylvan Learning Corporation's outstanding common stock. Following KEE's purchase of the stock of Sylvan Learning Corporation, the Partnership was dissolved, and all of its assets and liabilities were transferred to KEE. KEE changed its name to Sylvan KEE Systems, Inc. and later to Sylvan Learning Systems, Inc., in contemplation of the disposition of the assets of the KEE division. During 1993, Sylvan sold all of KEE's assets and liabilities for $2.2 million to Computer Innovations Distribution Inc., which operates under the name Computerland of Canada and is a subsidiary of SHL Systemhouse Inc. KEE's business had generated operating losses for all periods and is presented in the Statements of Operations as a discontinued operation. The selected statement of operations data for the year ended December 31, 1993 consists of the results of the Partnership for the month of January 1993, plus the results of Sylvan for the eleven months ended December 31, 1993. 11 The selected financial data for the years ended December 31, 1994, 1995, 1996 and 1997 have been derived from Sylvan's financial statements which have been audited by Ernst & Young LLP. The financial data should be read in conjunction with the historical Consolidated Financial Statements and Notes thereto. On May 30, 1997, the Company acquired by merger all of the outstanding stock of Educational Inroads. Educational Inroads provided contract educational services to school districts in New Jersey and several other states. On February 17, 1995, the Company acquired by merger all of the outstanding stock of Remedial Education and Diagnostic Services, Inc. and READS, Inc. (collectively, "READS"). READS is based in Philadelphia, Pennsylvania and provides remedial and education services, psychological, diagnostic and counseling services, career awareness training, and a variety of consulting services. Services are delivered under contracts with school districts, county-wide educational agencies and municipalities in the Eastern United States. During 1994, the Company acquired by merger all of the outstanding stock of Learning Services, Inc. "LSI") and all of the outstanding stock of Loralex Corporation ("Loralex"). These companies owned and operated a total of nine Sylvan Learning Centers located in the Northeast United States and Florida, respectively. All of these acquisitions have been accounted for by the Company as poolings-of-interests and, accordingly, the Company's financial statements have been restated for all periods prior to these acquisitions to include the results of operations of Educational Inroads, READS, LSI and Loralex. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Background." The selected statements of operations data include the operations of certain acquired businesses accounted for using the purchase method of accounting from the date of the respective acquisition, as further described in the notes to the accompanying schedule of Selected Consolidated Financial Data. 12 SELECTED CONSOLIDATED FINANCIAL DATA (1)
PARTNERSHIP AND SYLVAN COMBINED SYLVAN --------------- ------------------------------------------------------ YEAR YEAR YEAR YEAR YEAR ENDED ENDED ENDED ENDED ENDED DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, 1993 1994 1995 1996 1997 -------------- ------------ ------------ ------------ ------------ (THOUSANDS, EXCEPT PER SHARE DATA) STATEMENTS OF OPERATIONS DATA: Revenues:......................................... $51,519 $ 68,748 $ 111,059 $ 181,936 $ 246,212 Cost and expenses: Direct costs.................................... 44,056 60,388 96,708 150,449 206,621 General and administrative expense.............. 6,255 4,998 6,206 8,755 20,468 Loss on impairment of assets.................... -- -- 3,316 -- 4,000 ------- ------- -------- -------- -------- Total cost and expenses...................... 50,311 65,386 106,230 159,204 231,089 ------- ------- -------- -------- -------- Operating income................................ 1,208 3,362 4,829 22,732 15,123 Non-operating income (expense).................. (116) 224 391 363 27,974 Interest income (expense), net.................. (1,290) (62) (1,440) 551 2,401 ------- ------- -------- -------- -------- Income (loss) from continuing operations before income taxes and extraordinary items.......................................... (198) 3,524 3,780 23,646 45,498 Income taxes.................................... (7) (76) (209) (8,850) (16,064) ------- ------- -------- -------- -------- Income (loss) from continuing operations before extraordinary items.......... (205) 3,448 3,571 14,796 29,434 Discontinued operations (2): Loss from operations, net of tax.............. (375) -- -- -- -- Gain on disposal.............................. 580 -- -- -- -- ------- ------- -------- -------- -------- Income from discontinued operations........... 205 -- -- -- -- ------- ------- -------- -------- -------- Net income before extraordinary items........... -- 3,448 3,571 14,796 29,434 Extraordinary items (3)......................... (177) -- -- -- -- ------- ------- -------- -------- -------- Net income(loss).............................. $ (177) $ 3,448 $ 3,571 $ 14,796 $ 29,434 ======= ======= ======== ======== ======== Earnings (loss) per common share, basic (4): Income (loss) from continuing operations before extraordinary items.................... $(0.03) $0.24 $0.24 $0.64 $1.09 Income from discontinued operations............ 0.03 -- -- -- -- Extraordinary items............................ (0.03) -- -- -- -- ------ ----- ----- ----- ----- Earnings (loss) per common share, basic.......... $(0.03) $0.24 $0.24 $0.64 $1.09 ====== ===== ===== ===== ===== Earnings (loss) per common share, diluted (4): Income (loss) from continuing operations before extraordinary items..................... $(0.03) $0.21 $0.21 $0.60 $1.03 Income from discontinued operations............. 0.03 -- -- -- -- Extraordinary items............................. (0.03) -- -- -- -- ------ ----- ----- ----- ----- Earnings (loss) per common share, diluted........ $(0.03) $0.21 $0.21 $0.60 $1.03 ====== ===== ===== ===== ===== Shares used in computation (4): Basic........................................... 6,448 14,522 15,132 23,029 26,886 ======== ====== ====== ====== ======= Diluted......................................... 6,448 16,286 17,079 24,586 28,538 ======== ====== ====== ====== ======= BALANCE SHEET DATA (AT PERIOD END): Cash and cash equivalents......................... $11,499 $ 4,366 $ 2,903 $ 11,198 $ 23,150 Available-fore-sale securities.................... 1,248 2,537 30,735 16,449 82,926 Net working capital............................... 12,665 13,166 39,407 29,603 113,453 Intangible assets and deferred contract costs..... 7,000 7,932 82,849 122,932 194,576 Total assets...................................... 42,003 50,046 174,070 259,590 475,754 Long-term debt and capital leases................. 6,640 9,814 9,854 32,228 73,328 Stockholders' equity.............................. 24,563 32,481 137,148 180,323 340,371
(footnotes on next page) 13 (1) Prior to February 1, 1991, the Sylvan Learning Centers business was conducted by Sylvan Learning Corporation (the "Predecessor"). On February 1, 1991, the Predecessor contributed the Sylvan Learning Centers business to Sylvan KEE Systems, a Maryland general partnership (the "Partnership") in exchange for a 50% partnership interest, and Sylvan contributed its computer training software development business to the Partnership in exchange for the other 50% partnership interest. On January 26, 1993, Sylvan acquired the Predecessor and dissolved the Partnership. On September 3, 1993, Sylvan sold its computer training software development business. During 1994, Sylvan acquired by merger all of the outstanding stock of Learning Services, Inc. ("LSI") and all of the outstanding stock of Loralex Corporation ("Loralex"). These companies owned and operated a total of nine Sylvan Learning Centers located in the Northeast United States and Florida. On February 17, 1995, Sylvan acquired by merger all of the outstanding stock of Remedial Education and Diagnostic Services, Inc. and READS, Inc. (collectively, "READS"), a Philadelphia-based provider of remedial, education and a variety of consulting services to school districts, county- wide educational agencies and municipalities in the Eastern United States. The READS, Loralex and LSI acquisitions have been accounted for by Sylvan as poolings-of-interests and, accordingly, Sylvan's financial statements have been restated for all periods presented to include the results of operations of READS, Loralex and LSI. Effective September 30, 1995, Sylvan acquired Drake Prometric, L.P. ("Drake"), a leading provider of computer-based certification, licensure and assessment testing. The transaction was accounted for using the purchase method of accounting, and Sylvan's results of operations from October 1, 1995 include the operations of Drake. Effective December 1, 1996, Sylvan acquired Wall Street International, B.V., and its commonly controlled affiliates (collectively "Wall Street"), a European-based franchisor and operator of learning centers that teach the English language. This transaction was accounted for using the purchase method of accounting and Sylvan's results of operations from December 1, 1996 include the operations of Wall Street. Sylvan paid $4.9 million of the $20.1 million purchase price in cash and the remainder in 714,884 shares of Common Stock. On May 30, 1997, the Company consummated its acquisition by merger of all the outstanding common stock of Educational Inroads. Educational Inroads provides contract educational services to school districts in New Jersey and several other states. The Educational Inroads acquisition has been accounted for by Sylvan as a pooling-of-interests and, accordingly, Sylvan's financial statements have been restated for all periods prior to the acquisition to include the results of operations of Educational Inroads. Educational Inroads generated revenues of $24.8 million in 1996. Effective December 1, 1997, the Company purchased the assets and liabilities of Block Testing Services L.P. and Block State Testing Services L.P. and also acquired all of the outstanding common stock of National Assessment Institute, Inc., (collectively, "NAI/Block"), commonly controlled companies engaged in the business of designing, marketing, selling, distributing and administering paper and pencil tests for the licensing of individuals. The acquisition, which was paid for by issuing 642,901 shares of common stock valued at $24.6 million in January 1998, was accounted for using the purchase method of accounting, and Sylvan's results of operations from December 1, 1997 include the operations of NAI/Block. (2) Represents Sylvan's computer training software development business which was sold in September 1993 and a Canadian computer testing business, 80.1% of which was sold in 1992. (3) Represents the $350,000 gain on extinguishment of a $3.5 million debt to Learning Centers, Inc., and a $527,000 loss on an extinguishment of $5.0 million of notes payable to stockholders, each recorded in 1993. (4) In 1997, the Financial Accounting Standards Board issued Statement No. 128, Earnings Per Share ("Statement No. 128"). Statement No. 128 replaced the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options, warrants and convertible securities. Diluted earnings per share is very similar to the previously reported fully-diluted earnings per share. Earnings per share amounts for all periods have been 14 presented, and where appropriate, restated to conform to the Statement No. 128 requirements. In February 1998, the SEC issued Staff Accounting Bulletin No. 98 ("SAB No. 98"), which redefined "cheap stock" for registrants completing initial public offerings of their common stock. The 1993 earnings per share amount has been restated to conform to the requirements of SAB No. 98. 15 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ALL STATEMENTS CONTAINED HEREIN THAT ARE NOT HISTORICAL FACTS, INCLUDING BUT NOT LIMITED TO, STATEMENTS REGARDING THE ANTICIPATED IMPACT OF UNCOLLECTIBLE ACCOUNTS RECEIVABLE ON FUTURE LIQUIDITY, EXPENDITURES TO DEVELOP LICENSING AND CERTIFICATION TESTS UNDER EXISTING CONTRACTS, THE COMPANY'S CONTINGENT PAYMENT OBLIGATIONS RELATING TO THE DRAKE ACQUISITION, FUTURE CAPITAL REQUIREMENTS, POTENTIAL ACQUISITIONS AND THE COMPANY'S FUTURE DEVELOPMENT PLANS ARE BASED ON CURRENT EXPECTATIONS. THESE STATEMENTS ARE FORWARD LOOKING IN NATURE AND INVOLVE A NUMBER OF RISKS AND UNCERTAINTIES. ACTUAL RESULTS MAY DIFFER MATERIALLY. AMONG THE FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY ARE THE FOLLOWING: CHANGES IN THE FINANCIAL RESOURCES OF THE COMPANY'S CLIENTS; TIMING AND EXTENT OF TESTING CLIENTS CONVERSIONS TO COMPUTER-BASED TESTING; AMOUNT OF REVENUES EARNED BY THE COMPANY'S TESTING OPERATIONS; THE AVAILABILITY OF SUFFICIENT CAPITAL TO FINANCE THE COMPANY'S BUSINESS PLAN ON TERMS SATISFACTORY TO THE COMPANY; GENERAL BUSINESS AND ECONOMIC CONDITIONS; AND OTHER RISK FACTORS DESCRIBED IN THE COMPANY'S REPORTS FILED FROM TIME TO TIME WITH THE COMMISSION. THE COMPANY WISHES TO CAUTION READERS NOT TO PLACE UNDUE RELIANCE ON ANY SUCH FORWARD LOOKING STATEMENTS, WHICH STATEMENTS ARE MADE PURSUANT TO THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 AND, AS SUCH, SPEAK ONLY AS OF THE DATE MADE. OVERVIEW Sylvan generates revenues from three business segments: core educational services which primarily consist of franchise sales, royalties and Sylvan-owned Learning Center revenues; testing services, which consist of computer-based testing fees paid to Sylvan and the operations of WSI; and contract educational services, which consist of revenues attributable to providing supplemental remedial education services to public and non-public schools and major corporations. The following selected segment data is derived from the Company's audited consolidated financial statements.
YEAR YEAR YEAR ENDED ENDED ENDED DECEMBER 31, DECEMBER 31, DECEMBER 31, 1995 1996 1997 ------------ ------------ ------------ Operating revenue: Core educational services.................. $ 26,063 $ 36,799 $ 44,289 Contract educational services.............. 50,430 58,186 66,582 Testing services........................... 34,566 86,951 135,341 -------- -------- -------- Total revenue............................. 111,059 181,936 246,212 -------- -------- -------- Direct costs: Core educational services.................. 18,675 25,557 36,708 Contract educational services.............. 47,685 53,373 56,057 Testing services........................... 30,348 71,519 113,856 -------- -------- -------- Total direct costs........................ 96,708 150,449 206,621 -------- -------- --------
RESULTS OF OPERATIONS Comparison of results for the year ended December 31, 1997 to the year ended December 31, 1996. Revenues. Total revenues increased by $64.3 million, or 35%, to $246.2 million for the year ended December 31, 1997, compared to the same period in 1996. This increase resulted from higher revenues in all business segments -- core educational services, testing services and contract educational services. Core educational services revenues increased by $7.5 million, or 20%, to $44.3 million for 1997. Franchise royalties increased $1.9 million or 17%, for 1997. This increase in franchise royalties was due to an overall 10% 16 increase in revenues at existing Learning Centers open for more than one year combined with a net increase of 60 new Learning Centers opened in 1997. Franchise sales fees increased by $1.3 million, or 43%, to $4.5 million for the year ended December 31, 1997 compared to the same period in 1996. For the year ended December 31, 1997, there were six area development agreements sold for $2.9 million and 42 franchise Center licenses sold, as compared to 38 franchise Center licenses and four area development agreements sold for $1.7 million in the same period in 1996. Product sales decreased by $190,000, or 5%, to $3.7 million for 1997. Revenues from Company-owned Learning Centers increased by $4.2 million, or 22%, to $22.7 million during 1997. Revenue growth related to student enrollment increases for Centers operating over 12 months as of December 31, 1997 resulted in $4.0 million, or 24%, of the increase for 1997 compared to 1996. Approximately $1.1 million of the revenue increase resulted from the acquisition of thirteen centers from five franchisees. Contract educational services revenue increased by $8.4 million, or 14%, to $66.6 million for the year ended December 31, 1997. Revenue from public and non-public contracts increased by $2.2 million for the year ended December 31, 1997, primarily the result of contracts with new school districts. Revenue from PACE contracts accounted for $6.2 million of the increase for 1997. The PACE increase resulted primarily from contracts with new customers. Revenue from new public and non-public contracts obtained after December 31, 1996 contributed $5.3 million to revenue for 1997. Revenue from existing public and non-public contracts obtained before December 31, 1996 decreased by $3.1 million in 1997, primarily related to reduced funding in certain school districts and certain contracts expiring in 1997. Testing services revenue increased by $48.3 million, or 56%, to $135.3 million during the year ended December 31, 1997, compared to the year ended December 31, 1996. The increase in testing services revenues resulted mainly from increased services under Educational Testing Service (ETS) contracts, which included the cost-plus international contract, GRE, GMAT, and TOEFL, and certain volume-based pricing adjustments, testing in the information technology and professional licensure businesses. WSI, acquired in December 1996, contributed $19.0 million of the revenue increase. Cost and Expenses. Total direct costs increased 37%, from $150.4 million in 1996 to $206.6 million in 1997 and increased as a percentage of total revenues from 83% in 1996 to 84% in 1997 as a result of non-recurring expenses of $21.5 million being included in direct costs in 1997, as discussed below. Excluding the non-recurring expenses, total direct costs as a percentage of total revenues would be 75% for the year ended December 31, 1997. Core educational services expense increased 44% from $25.6 million in 1996 to $36.7 million in 1997. Included in core educational services expense for the 1997 period is advertising expense related to a non-recurring $5.0 million contribution of the Company's common stock to a non-profit corporation whose sole purpose is to develop and fund advertising programs for the Sylvan Learning Centers. Franchise services expense increased by $8.0 million, to $17.5 million or 82% of franchise related revenues for the year ended December 31, 1997, compared to $9.5 million, or 52% of franchise related revenues for the year ended December 31, 1996. The lower margin in franchise services was primarily due to the non-recurring expense discussed above, as well as to costs incurred for development of new financing and after-school programs and additional management staff for the Learning Center division. Company-owned Learning Center expense increased by $3.1 million, to $19.2 million or 85% of Company-owned Learning Center services revenues for the year ended December 31, 1997, compared to $16.1 million, or 87% of Company-owned Learning Center services revenues for the year ended December 31, 1996. The increase resulted from $1.1 million of expenses associated with 13 acquired Learning Centers, and increases in advertising, labor and general overhead associated with increased Center enrollment. Expenses for Centers operating over 12 months as of December 31, 1997 accounted for $2.0 million of the increase for 1997. 17 Contract educational services expense increased by $2.7 million to $56.1 million, or 84% of contract educational services revenues during 1997, compared to $53.4 million, or 92% of contract educational services revenues during 1996. Operating expenses for public and non-public schools decreased $1.3 million, while operating expenses for PACE increased by $3.5 million for the year ended December 31, 1997. The decrease in contract educational services expense as a percentage of revenue for 1997 versus 1996 is the result of increased profit margins for PACE and public and non-public services in 1997, as well a higher mix of revenue from PACE contracts which generate a higher profit margin than public and non-public services. In March 1998, the additional contingent consideration payable to the former shareholders of PACE resulting from the purchase of PACE in 1995 was determined to be $25.8 million, which was recorded as additional goodwill and is being amortized over the estimated remaining useful life of 22 years. This amount will increase the amount of amortization associated with the contract educational services segment by $1.2 million in 1998. Testing service expenses for the year ended December 31, 1997 increased by $42.4 million to $113.9 million, or 84% of total testing services revenue, compared to $71.5 million, or 82% of total testing services revenue for the year ended December 31, 1996. The increase in testing services expense as a percentage of testing services revenues was predominantly a result of a non- recurring marketing expense of $10.0 million related to a contribution to IT Training Marketing Company, a nonprofit corporation whose sole purpose is to fund promotional and channel support programs for the Sylvan Prometric distribution channel. The 1996 expense includes $2.4 million of non-recurring charges related to the Drake acquisition, incurred during the first and second quarter of 1996. Excluding these effects, expenses as a percentage of total testing revenue for 1997 and 1996 were 77% and 79%, respectively. This decrease in recurring expenses as a percentage of testing services revenue was primarily due to the fixed expenses of the division being spread over a higher revenue base as well as the effects of a full year of results of WSI, at higher incremental margins, being included in 1997 compared to only one month in the 1996 period. General and administrative expenses increased by $11.7 million to $20.5 million during 1997 and increased as a percentage of revenues from 4.8% to 8.3%. Included in general and administrative expenses is a non-recurring expense related to a contribution of the Company's common stock valued at $6.5 million to Sylvan Learning Foundation, Inc., a nonprofit foundation formed to promote various educational pursuits. Excluding this non-recurring expense, general and administrative expenses are 5.7% of total revenues for 1997. The expenses did not decrease as a percentage of revenues as a result of increased administrative staff, leased space costs and other expenses which were added to support the current and expected growth in the Company's three divisions. In March 1997, the Company and National Education Corporation ("NEC") executed a definitive agreement pursuant to which the Company was to acquire NEC. In May 1997, NEC accepted a competing offer which resulted in the termination of NEC's agreement with the Company. As a result, NEC paid the Company a $30.0 million termination fee, which has been recorded, net of $1.5 million of transaction costs, as a separate component of non-operating income. In May 1997, the Company determined that certain assets of Sylvan Prometric were impaired as a result of certain strategic changes that were made as a result of pursuing the NEC acquisition. During and after the acquisition negotiations with NEC, the Company developed certain plans that resulted in required changes in both software systems and hardware currently utilized in Sylvan Prometric's network of centers. The plans continued to be valid for the Company even after the NEC acquisition was terminated. The impaired assets, consisting of computer equipment and software, were impaired as a result of changes in the technical requirements and specifications of certain computer hardware and software. The amount of the impairment loss was determined by evaluating the likely sales proceeds from the disposition of the assets compared to their book value. The Company determined that it was unlikely that the net cash proceeds from the sale of any assets would be significant, and therefore recorded an impairment loss equal to the net book value of the assets of $4.0 million. Investment and other income increased by $2.9 million to $4.5 million during 1997, primarily due to the $2.0 million non-cash dividend income received from the Company's investment in JLC Holdings, Inc. and the higher 18 cash and investment balances resulting from the NEC termination fee and the proceeds received from the sale of the Company's common stock during 1997. The Company's interest expense decreased by $0.5 million due to the repayment of all outstanding Educational Inroads debt in the second quarter of 1997. The Company reported losses of $2.1 million in 1997 from its investment in affiliates, consisting primarily of $1.4 million attributable to Caliber Learning Network, Inc., in which the Company has an equity investment. The Company and MCI Communications Corp. organized Caliber in November of 1996. The Company's effective tax rate has decreased from 37% during the 1996 to 35% during 1997 mainly due to the effect of proportionately higher earnings levels attributable to foreign countries with lower tax rates than the U.S. 19 Comparison of results for the year ended December 31, 1996 to the year ended December 31, 1995. Revenues. Total revenues increased 64%, from $111.1 million in 1995 to $181.9 million in 1996. This increase resulted from greater revenues in all business segments--core educational services, testing services and contract educational services. Core educational services revenues increased 41%, from $26.1 million in 1995 to $36.8 million in 1996. Franchise royalties increased 21%, from $9.2 million in 1995 to $11.2 million in 1996. This increase in franchise royalties was due to an overall 19% increase in revenues at Learning Centers that had been operating for more than one year as of December 31, 1996 combined with a net increase of 49 Learning Centers opened during 1996. Franchise sales fees increased 49%, from $2.1 million in 1995 to $3.2 million in 1996. During 1996, there were four area development agreements sold for $1.7 million and 38 franchise Learning Center licenses sold, compared to two area development agreements sold for $550,000 and 43 Learning Center licenses sold during 1995. Revenues from Company-owned Learning Centers increased 61%, from $11.5 million in 1995 to $18.5 million in 1996. Revenue growth related to increased student enrollment at Learning Centers that had been operating for more than one year as of December 31, 1996, resulted in $3.4 million, or 30%, of the increase from 1995 to 1996. Approximately $3.2 million of the revenue increase resulted from the acquisition of 11 Learning Centers from two franchisees. The opening of one new Learning Center during 1996 resulted in an additional $350,000 of revenues during 1996. Product sales increased 23%, from $3.2 million in 1995 to $3.9 million in 1996. This increase resulted from overall student enrollment increases at franchised Learning Centers. Contract educational services revenues increased 15%, from $50.4 million in 1995 to $58.2 million in 1996. Revenues from public and non-public school contracts accounted for $5.9 million of the increase, and greater revenues from PACE accounted for $1.9 million of the increase. The PACE increase primarily resulted from the fact that the acquisition, accounted for as a purchase, was effective February 28, 1995, and as such the 1995 revenues of Sylvan only reflect ten months of PACE revenues. Revenues from public and non-public school contracts executed during 1996 contributed $2.2 million to 1996 revenues. Revenues from public and non-public school contracts executed during 1995 increased by $4.6 million in 1996, primarily because a full year of revenues were generated under these contracts during 1996. Testing services revenues increased 152%, from $34.6 million in 1995 to $87.0 million in 1996. The significant increase in testing services revenues resulted primarily from the September 1995 acquisition of Drake, which provided increased revenues from IT clients. Increased services under ETS contracts, including the cost-plus international contract and the Graduate Record Exam (the "GRE"), and other professional testing revenue increases, including NASD testing, which began in February 1996, also contributed to the increase in testing services revenues. Cost and Expenses. Total direct costs increased 56%, from $96.7 million in 1995 to $150.4 million in 1996, but decreased as a percentage of total revenues from 87% in 1995 to 83% in 1996. Core educational services expense increased 37%, from $18.7 million in 1995 to $25.6 million in 1996. Franchise services expense increased 11%, from $5.9 million in 1995 to $6.5 million in 1996 but decreased as a percentage of franchise royalties and sales revenues from 52% in 1995 to 46% in 1996. The increased margin in 1996 primarily related to the effects of leveraging the fixed costs of supporting this line of business over a larger revenue base. Company-owned Learning Center expense increased 55%, from $10.4 million in 1995 to $16.1 million in 1996 but decreased as a percentage of Company-owned Learning Center services revenues from 90% in 1995 to 87% in 1996. Of the increase, $3.1 million related to the acquisition of 11 Learning Centers. The remaining increase is primarily from advertising, labor and general overhead expense associated with increased enrollment at Learning Centers that had been operating prior to 1996. 20 Contract educational services expense increased 12%, from $47.7 million in 1995 to $53.4 million in 1996 but decreased as a percentage of contract educational services revenues from 95% in 1995 to 92% in 1996. The decline in these expenses as a percentage of contract educational services revenues resulted from increased revenues without corresponding increases in overhead. Operating expenses for public and non-public school contracts increased $4.6 million during 1996, while operating expenses for PACE increased $1.1 million during the same period. The PACE increase resulted from the fact that the acquisition, accounted for as a purchase, was effective February 28, 1995, and as such the 1995 results only reflect ten months of PACE results. Testing services expense increased 136%, from $30.3 million in 1995 to $71.5 million in 1996 but decreased as a percentage of testing services revenue from 88% in 1995 to 82% in 1996. The increased expense resulted primarily from the acquisition of Drake and the increased registration and delivery costs associated with an increased volume of tests. Testing services expense in 1996 included $2.4 million of amortization of contract rights related to the Drake acquisition. Testing services expense in 1995 included $4.1 million of amortization of contract rights, imputed interest and salary termination charges related to the Drake acquisition. Excluding non-recurring charges, testing services expense, as a percentage of testing services revenues, increased from 76% in 1995 to 79% in 1996. The principal reasons for this percentage increase in 1996 are the full year amortization of goodwill associated with the Drake acquisition and increased staffing levels required to meet the growth in business volumes that occurred during 1996 and expected growth in business activity in 1997. General and administrative expense increased 41%, from $6.2 million in 1995 to $8.8 million in 1996, but decreased as a percentage of total revenues, from 6% in 1995 to 5% in 1996. The percentage decline resulted from increased revenues in all segments without corresponding increases in overhead. There was $1.4 million of net interest expense in 1995 and $0.6 million of net interest income in 1996. This change resulted primarily from the $1.1 million of interest expense imputed on the purchase of Drake and an increase in the average invested cash amounts in 1996 compared to 1995. The Company's effective tax rate increased from 6% in 1995 to 37% in 1996. This increase was the primarily the result of a 1995 decrease in the amount of the valuation allowance for deferred tax assets, consisting principally of net operating loss carryforwards. LIQUIDITY AND CAPITAL RESOURCES Cash provided by operating activities increased $31.9 million, from $23.6 million in 1996 to $55.5 million in 1997. This increase is attributable to a variety of factors, the most significant of which was a $35.5 million increase in operating income before non-cash charges. Sylvan's investment in working capital continues to reduce net cash flow from operations, particularly as a result of the growth in accounts and notes receivable. The $26.4 million increase in accounts and notes receivable is principally the result of a 35% increase in revenue during 1997. Of the $26.4 million cash flow reduction attributable to an increase in accounts and notes receivable, $12.3 million is related to Sylvan's expanding testing contracts and $3.8 million is related to new and expanded public school contracts. The increase in amounts due from expanding testing contracts resulted from higher domestic testing volumes and a significant increase in billings under the international contract with ETS to establish overseas testing capacity. ETS typically makes monthly payments for domestic activity and quarterly payments for international services. Accounts receivable from public school-based programs have increased due to billings under new contracts obtained in 1996 and 1997. Notes receivable for new area development agreements accounted for $3.2 million of the increase in 1997 and a note receivable from one of the former owners of WSI accounted for another $2.0 million. Increases in revenue for all business segments contributed to the remaining accounts and note receivable increase of $5.1 million. Sylvan believes that uncollectible accounts receivable will not have a significant effect on future liquidity, as a significant portion of its accounts receivable are due from enterprises with substantial financial resources, such as ETS and governmental units. 21 Cash flow from operations in 1997 was favorably impacted by an increase in accounts payable, accrued expenses and income taxes payable of $16.3 million. This increase relates to the overall increase in expenses, including income taxes, of $79.4 million. The Company's investing activities include the investment of excess cash in available-for-sale securities. During 1997, the Company's investments increased $66.5 million to $82.9 million. These investments are readily marketable and available for use in current operations. The Company also made $9.3 million of additional investments or loans to affiliates accounted for using the equity method, consisting primarily of additional investments and loans to Caliber Learning Network, Inc., in the amount of $7.2 million. In January 1997, the Company completed the acquisition of WSI and paid cash to the sellers and incurred acquisition costs totaling $4.7 million. Sylvan continues to incur expenditures for additions to property and equipment, which totaled $28.7 million in 1997. These additions consist primarily of furniture and equipment for general business expansion, including expenditures for the headquarters facility, new public school-based programs' classrooms, and equipment needed for overseas testing centers operated by Sylvan. Under the international testing contract with ETS, Sylvan is reimbursed for overseas equipment expenditures as the equipment is depreciated. This reimbursement includes a financing charge over the reimbursement period. The Company has entered into a loan agreement with a bank, (hereinafter the "credit line") that provides an unsecured revolving line of credit. The credit line allows the Company to borrow a maximum of $15.0 million through the expiration date of May 31, 1998, at which time the total outstanding principal balance can be converted into a term loan, at the option of the Company. The term loan would be repaid over 24 months from the date of issuance. The credit line and the term loan both bear interest at a floating rate equal to the 30 day London Interbank Offered Rate ("LIBOR") plus 1.15% per annum. The credit line had no outstanding borrowings at December 31, 1997. In the third quarter of 1997, the Company issued 2,062,292 shares of its common stock for net proceeds of $73.7 million, after underwriting costs and expenses. The Company also received $5.0 million of cash as a result of the exercise of stock options and warrants to purchase 1,137,245 shares of common stock in 1997. The Company will be required to make cash payments of $13.5 million in 1998 to the former shareholders of PACE in settlement of contingent consideration arising from the 1995 acquisition of PACE. This amount has been classified as a current liability in the consolidated balance sheet at December 31, 1997. Also, as of December 31, 1997, the Company is obligated to issue directly to certain shareholders of acquired companies common stock with a value of $56.4 million. This amount is classified as a long-term liability in the consolidated balance sheet at December 31, 1997. The Company has nominal amounts of long-term debt outstanding at December 31, 1997. Sylvan believes that its capital resources will be sufficient over the next 12 to 24 months to fund expected expansion of its business, including working capital needs and expected investments in property and equipment. Sylvan continues to review other companies in the education or computer-based testing industries for potential acquisitions. Additional capital resources may be necessary to acquire and thereafter operate additional businesses. CONTINGENT MATTERS In connection with the PACE acquisition, Sylvan will be required to make a contingent payment equal to 6.5 times PACE's 1997 earnings before interest and income taxes ("EBIT"). EBIT in 1997 was $4.0 million, resulting in additional consideration of $25.8 million. The contingent payment is payable $13.5 million in cash ($14.5 million offset by $1.0 million of amounts owed the Company by the former owners of PACE) and the remainder in shares of common stock. The Company has recorded this additional consideration as a liability and increased goodwill and will amortize that amount over the remaining estimated recovery period. 22 Upon the acquisition of Drake in September 1995, the Company entered into two contingent payment obligations related to the acquisition. The first related to 1,785,714 shares of common stock (the "Revenue Escrow Shares") that were placed in escrow to be released to the sellers provided certain revenue targets relating to portions of the computer-based testing business are achieved from 1996 through 1998. Based on testing revenues earned by the Company in 1996 and 1997, 60% of the Revenue Escrow Shares (1,071,429 shares) have been earned through December 31, 1997. As of December 31, 1997, an additional $28.2 million of goodwill related to the earned shares was recorded and will be amortized over the remaining estimated useful life. The 714,286 Revenue Escrow Shares earned in 1997 will be released to the sellers in 1998. The sellers of Drake may receive up to an additional $40.0 million (payable 12.5% in cash and the balance in either cash or restricted shares of common stock, at the Company's option) as a second component of contingent consideration. This component will be earned if other revenue targets relating to portions of the combined computer-based testing business are achieved in 1998 or 1999 (with the measuring year selected by the sellers). Sylvan has put in place a corporate-wide Year 2000 task force with representatives for each business segment. This task force has conducted a comprehensive review of Sylvan's computer systems to identify the systems that would be affected by the Year 2000 issue and is developing an implementation plan to resolve the issues. The Company is also surveying critical suppliers and customers to determine the status of their Year 2000 compliance programs. The Company presently believes that, with modifications to the existing systems and implementation of new hardware and software, the Year 2000 project will not pose any significant operational problems. The Company anticipates completing the Year 2000 project by June of 1999. The future and total costs relating to the Year 2000 issue are not expected to have a material impact on the Company's consolidated financial position, results of operations or cash flow. EFFECTS OF INFLATION Inflation has not had a material effect on Sylvan's revenues and income from continuing operations in the past three years. Inflation is not expected to have a material future effect. QUARTERLY FLUCTUATIONS Sylvan's revenues and operating results have varied substantially from quarter to quarter and may continue to vary, depending upon the timing of implementation of new computer-based testing contracts and contracts funded under Title I or similar programs. Based on Sylvan's limited experience, revenues generated by computer-based testing services may vary based on the frequency or timing of delivery of individual tests and the speed of test administrators' conversion of tests to computer-based format. In addition, franchise license fees earned by the Company in its core educational services and testing services segments may vary significantly from quarter to quarter. Revenues or profits in any period will not necessarily be indicative of results in subsequent periods. ITEM 8. FINANCIAL STATEMENTS The financial statements of the Company are included on pages 29 through 63 of the report as indicated on page 28. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE There were no changes in accountants, disagreements, or other events requiring reporting under this Item. 23 PART III. --------- ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF SYLVAN LEARNING SYSTEMS, INC. Information required is set forth under the caption "Election of Directors" in the Proxy Statement relating to the 1998 Annual Meeting of Shareholders, which is incorporated by reference. Information required pertaining to compliance with Section 16 (a) of the Securities and Exchange Act of 1934 is set forth under the caption "Election of Directors" in the Proxy Statement relating to the 1998 Annual Meeting of Shareholders, which is incorporated by reference. ITEM 11. EXECUTIVE COMPENSATION Information required is set forth under the caption "Executive Compensation" in the Proxy Statement relating to the 1998 Annual Meeting of Shareholders, which is incorporated by reference. ITEM 12. SECURITY OWNERSHIP AND CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information required is set forth under the caption "Security Ownership" in the Proxy Statement relating to the 1998 Annual Meeting of Shareholders, which is incorporated by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information required is set forth under the caption "Certain Transactions" in the Proxy Statement relating to the 1998 Annual Meeting of Shareholders, which is incorporated by reference. PART IV. -------- ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) The following documents are filed as a part of this report: 1. FINANCIAL STATEMENTS The response to this portion of Item 14 is submitted as a separate section of this Report. 2. FINANCIAL STATEMENT SCHEDULES All schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are inapplicable or immaterial and therefore have been omitted. (b) Reports on Form 8-K: The Registrant did not file any reports on Forms 8-K and 8-K/A during the fourth quarter ended December 31, 1997. 3. EXHIBITS 24 (a) Exhibits:
Exhibit Number Description - ------------ ----------- 3.01 Articles of Amendment and Restatement of the Charter.(b) 3.03 Amended and Restated Bylaws dated September 27, 1996.(n) 4.01 Specimen Common Stock Certificate.(b) 4.02 Form of Warrant to Purchase Common Stock of Sylvan KEE Systems, Inc. dated January 26, 1993.(b) 4.03 Form of Warrant to Purchase Common Stock of Sylvan KEE Systems, Inc. dated July 14, 1993.(b) 4.07 Rights Agreement by and between Registrant and State Street Bank & Trust Company dated as of October 1, 1996.(i) 5.01 Opinion of Piper & Marbury L.L.P.(a) 10.01 Agreement of Lease by and between Rouse & Associates-Quarry and KEE Systems, Inc. dated May 15, 1990.(b) 10.02 Agreement of Lease by and between Rouse & Associated-Quarry and KEE Systems, Inc. dated May 6, 1990.(b) 10.03 Lease Agreement between Harbor East Parcel G-Office, LLC and Sylvan Learning Systems, Inc. dated August 24, 1995(c) 10.04 Master Agreement Between Educational Testing Service and Sylvan Learning Systems, Inc. for Computer-Based Testing Services at Sylvan Technology Centers dated September 1, 1993. (Portions of this document have been omitted pursuant to a request for confidential treatment.)(b) 10.05 Term Lease Master Agreement between Sylvan Learning Systems and IBM Credit Corporation dated March 31, 1992.(b) 10.06 Director Stock Option Plan.(b) 10.07 Employee Stock Option Plan.(b) 10.08 Management Stock Option Plan.(b) 10.19 KEE, Incorporated Non-Qualified Stock Option Plan.(b) 10.10 Sylvan Employee Confidentiality and Non-Disclosure Agreement and Covenant Not to Compete.(b) 10.11 $2.5 Million Revolving Loan, $3.76 Million Term Loan and $5.0 Million Revolving Loan with NationsBank.(d) 10.12 Indemnification Agreement by and between Sylvan KEE Systems, Tom D. Wippman and David H. Jacobson dated September 17, 1992.(b) 10.13 Guaranty Agreement by Sylvan KEE Systems in favor of Encyclopedia Britannica, Inc. dated October 1, 1992.(b) 10.14 Form of Non-Competition Agreement by and between Sylvan KEE Systems, Inc. and Douglas L. Becker dated January 26, 1993.(b) 10.15 Certification and Testing Services Agreement by and between TRO Learning, Inc. and Sylvan Learning Systems, Inc. dated August 31, 1993.(b) 10.16 Plato Educational Products Purchase and License Agreement by and between TRO Learning, Inc. and Sylvan Learning Systems, Inc. dated August 31, 1993.(b) 10.17 Form of Franchise Agreement.(b) 10.18 Form of Technology Center Agreement.(b) 10.19 Agreement and Plan of Reorganization dated July 14, 1994 by and between Registrant and Learning Services, Inc.(e) 10.20 Agreement and Plan of Reorganization dated July 14, 1994 by and between Registrant and Loralex Learning, Inc.(e) 10.21 Agreement and Plan of Reorganization dated February 17, 1995 by and between Registrant and Remedial Education and Diagnostic Services, Inc.(f) 10.22 Agreement and Plan of Reorganization dated as of March 1, 1995, by and between Registrant and the PACE Group.(g) 10.23 Agreement and Plan of Reorganization dated as of July 28, 1995, by and between Registrant and Drake Prometric, L.P.(h)
25
10.24 Lease Agreement dated August 24, 1995, First Amendment dated May 13, 1996 and Second Amendment dated November 11, 1996 by and between Registrant and Harbor East, LLC.(n) 10.25 Revolving Credit Note to NationsBank, N.A. dated December 31, 1996.(n) 10.26 Senior Management Option Plan dated March 29, 1996.(n) 10.27 Securities Purchase Agreement by and between Registrant and JLC Holdings, Inc., Software Systems Corporation and JLC Learning Corporation dated November 1, 1996.(j) 10.28 Agreement and Plan of Reorganization dated January 28, 1997 by and between Registrant and Wall Street Institute.(k) 10.29 Agreement and Plan of Reorganization dated May 30, 1997 among Registrant and I-R, Inc. and Independent Child Study Teams, Inc.(l) 10.30 Sylvan Learning Systems, Inc. Employee Stock Purchase Plan.(m) 21.00 Subsidiaries of the Registrant.(n) 23.01 Consent of Ernst & Young LLP. 23.02 Consent of Deloitte & Touche L.L.P. 27.01 Financial Data Schedule for the year ended December 31, 1997. 27.02 Financial Data Schedule for the years ended December 31, 1995 and 1996. 27.03 Financial Data Schedule for the three months ended March 31, 1997 and 1996. 27.04 Financial Data Schedule for the three months ended June 30, 1997 and 1996. 27.05 Financial Data Schedule for the six months ended June 30, 1997 and 1996. 27.06 Financial Data Schedule for the three months ended September 30, 1997 and 1996. 27.07 Financial Data Schedule for the nine months ended September 30, 1997 and 1996. 99.01 Opinion of Deloitte & Touche L.L.P. 99.02 Opinion of Deloitte & Touche L.L.P.
(a) Incorporated by reference from the Exhibits to the Company's Registration Statement on Form S-1 dated February 26, 1996. (b) Incorporated by reference from the Exhibits to the Company's Registration Statement on Form S-1 (Registration No. 33-69558). (c) Incorporated by reference from the Exhibits to the Company's Registration Statement on Form S-3 as amended by a Registration Statement on Form S-1 (No. 33-97870). (d) Incorporated by reference from the Exhibits to the Company's Quarterly Report for the Quarter ended September 30, 1995. (e) Incorporated by reference to the Company's Current Report on Form 8-K dated July 20, 1994. (f) Incorporated by reference to the Company's Current Report on Form 8-K dated February 27, 1995. (g) Incorporated by reference to the Company's Current Report on Form 8-K dated May 5, 1995. (h) Incorporated by reference to the Company's Current Report on Form 8-K dated July 21, 1995. (i) Incorporated by reference to the Company's Current Report on Form 8-K dated September 27, 1996. (j) Incorporated by reference to the Company's Current Report on Form 8-K dated November 1, 1996. (k) Incorporated by reference to the Company's Current Report on Form 8-K dated January 28, 1997. (l) Incorporated by reference to the Company's Current Report on Forms 8-K and Form 8-K/A dated April 17, 1997 and May 30, 1997. (m) Incorporated by reference from the Exhibits to the Company's Registration Statement on Form S-8 dated February 18, 1997. (n) Incorporated by reference from the Exhibits to the Company's Form 10-K filed March 31, 1997. 26 SIGNATURES ---------- Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf of the undersigned, thereunto duly authorized on March 31, 1998. SYLVAN LEARNING SYSTEMS, INC. (Registrant) By: /s/ R. Christopher Hoehn-Saric ------------------------------------ R. Christopher Hoehn-Saric Chairman of the Board Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on March 31, 1998 SIGNATURE CAPACITY - --------- -------- /s/ R. Christopher Hoehn-Saric Director and Chairman of the Board - ------------------------------------------ R. Christopher Hoehn-Saric /s/ Douglas L. Becker Secretary - ------------------------------------------ Douglas L. Becker /s/ B. Lee McGee Vice President and Chief - ------------------------------------------ Financial Officer B. Lee McGee /s/ Donald Berlanti Director - ------------------------------------------ Donald Berlanti /s/ Phillip Samper Director - ------------------------------------------ Phillip Samper /s/ James H. McGuire Director - ------------------------------------------ James H. McGuire /s/ Rick Inatome Director - ------------------------------------------ Rick Inatome /s/ R. William Pollock Director - ------------------------------------------ R. William Pollock /s/ Nancy S. Cole Director - ------------------------------------------ Nancy S. Cole 27 ITEM 14 (A) (1) INDEX TO FINANCIAL STATEMENTS
PAGE ---- THE COMPANY: Report of Independent Auditors............................................................... 29 Consolidated Balance Sheets as of December 31, 1996 and December 31, 1997.................... 30 Consolidated Statements of Income for the years ended December 31, 1995, 1996 and 1997....... 32 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1995, 1996 and 1997................................................................................... 33 Consolidated Statements of Cash Flows for the years ended December 31, 1995, 1996 and 1997... 34 Notes to Consolidated Financial Statements................................................... 35
28 Report of Independent Auditors The Board of Directors and Stockholders Sylvan Learning Systems, Inc. We have audited the consolidated balance sheets of Sylvan Learning Systems, Inc. as of December 31, 1997 and 1996, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the financial statements of I-R, Inc. and Independent Child Study Teams, Inc., which statements reflect combined total assets constituting 3% of 1996 consolidated total assets, and which reflect combined revenues constituting 14% and 21% of consolidated total revenues for the years ended December 31, 1996 and 1995. Those statements were audited by other auditors whose reports have been furnished to us, and our opinion, insofar as it relates to data included for I-R, Inc. and Independent Child Study Teams, Inc., is based solely on the reports of the other auditors. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the reports of other auditors provide a reasonable basis for our opinion. In our opinion, based on our audits and the reports of other auditors, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Sylvan Learning Systems, Inc. at December 31, 1997 and 1996, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. /s/ Ernst & Young LLP Baltimore, Maryland February 25, 1998 29 SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
December 31, December 31, 1996 1997 --------------- --------------- ASSETS Current assets: Cash and cash equivalents $ 11,198,106 $ 23,150,106 Available-for-sale securities 16,448,759 82,925,569 Receivables: Accounts receivable 36,431,363 56,187,522 Costs and estimated earnings in excess of billings on uncompleted contracts 3,565,201 3,899,760 Notes receivable 3,007,473 2,942,861 Other receivables - 7,000,000 --------------- --------------- 43,004,037 70,030,143 Allowance for doubtful accounts (1,378,854) (1,754,682) --------------- --------------- 41,625,183 68,275,461 Inventory 4,469,577 4,777,542 Deferred income taxes 619,553 3,737,831 Prepaid expenses and other current assets 3,124,802 3,674,563 --------------- --------------- Total current assets 77,485,980 186,541,072 Notes receivable, less current portion 562,989 6,231,651 Costs and estimated earnings in excess of billings on uncompleted contracts, less current portion 549,448 351,712 Property and equipment: Furniture and equipment 37,952,268 55,381,518 Leasehold improvements 5,543,726 7,649,845 --------------- --------------- 43,495,994 63,031,363 Accumulated depreciation (15,577,693) (18,725,260) --------------- --------------- 27,918,301 44,306,103 Intangible assets: Goodwill 103,986,427 182,167,949 Contract rights 13,881,337 13,972,800 Other 2,570,091 2,522,391 --------------- --------------- 120,437,855 198,663,140 Accumulated amortization (10,736,219) (16,649,374) --------------- --------------- 109,701,636 182,013,766 Deferred contract costs, net of accumulated amortization of $2,066,893 as of December 31, 1996 and $6,205,393 as of December 31, 1997 13,230,340 10,323,898 Investments in and advances to affiliates 5,895,602 12,463,729 Other investments 22,219,888 28,017,457 Other assets 2,025,337 3,266,176 --------------- --------------- Total assets $ 259,589,521 $ 473,515,564 =============== ===============
30 SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
December 31, December 31, 1996 1997 ------------------- ------------------- LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and accrued expenses $ 28,575,931 $ 36,435,373 Income taxes payable - 4,876,458 Current portion of long-term debt 3,182,197 930,231 Current portion of due to shareholders of acquired companies 4,920,565 13,794,195 Deferred revenue 9,542,578 11,751,722 Other current liabilities 1,661,776 779,415 ------------------- ------------------- Total current liabilities 47,883,047 68,567,394 Long-term debt, less current portion 2,170,101 - Deferred income taxes 2,338,154 7,334,903 Due to shareholders of acquired companies, less current portion 26,525,855 56,365,578 Other long-term liabilities 349,771 876,809 Commitments and contingent liabilities - - Stockholders' equity: Preferred stock, par value $.01 per share--authorized 10,000,000 shares, no shares issued and outstanding as of December 31, 1997 and 1996 - - Common stock, par value $.01 per share--authorized 40,000,000 shares, issued and outstanding shares of 23,980,215 as of December 31, 1996 and 28,964,278 as of December 31, 1997 239,802 289,643 Additional paid-in capital 168,547,097 301,390,840 Retained earnings 11,550,868 39,652,003 Unrealized losses on available for sale securities (11,043) - Foreign currency translation adjustments (4,131) (961,606) ------------------- ------------------- Total stockholders' equity 180,322,593 340,370,880 ------------------- ------------------- Total liabilities and stockholders' equity $ 259,589,521 $ 473,515,564 =================== ===================
See accompanying notes. 31 SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, ---------------------------------------------------------- 1995 1996 1997 ---------------------------------------------------------- REVENUES $ 111,058,550 $ 181,935,961 $ 246,211,733 COST AND EXPENSES Direct costs 96,708,097 150,448,547 206,620,955 General and administrative expense 6,205,480 8,755,406 20,467,883 Loss on impairment of assets 3,315,541 - 4,000,000 ------------------ ---------------- ---------------- Total expenses 106,229,118 159,203,953 231,088,838 ------------------ ---------------- ---------------- Operating income 4,829,432 22,732,008 15,122,895 OTHER INCOME (EXPENSE) Termination fee, net of direct costs - - 28,500,000 Investment and other income 957,169 1,622,240 4,532,203 Interest expense (2,396,803 (1,071,323) (525,859) Equity in net income (loss) of affiliates 390,692 363,396 (2,131,240) ------------------ --------------- -------------- Income before income taxes 3,780,490 23,646,321 45,497,999 Income taxes (209,159 (8,850,000) (16,064,000) ------------------ --------------- --------------- Net income $ 3,571,331 $ 14,796,321 $ 29,433,999 ================== ================ =============== Earnings per common share, basic $ 0.24 $ 0.64 $ $1.09 ================== =============== =============== Earnings per common share, diluted $ 0.2 $ 0.60 $ $1.03 ==================== ================ ==============
See accompanying notes. 32 SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES Consolidated Statements of Stockholders' Equity
RETAINED ADDITIONAL EARNINGS COMMON PAID-IN (ACCUMULATED STOCK CAPITAL DEFICIT) ---------- -------------- --------------- Balance at January 1, 1995 $ 145,713 $ 38,851,651 $ (6,496,973) Options and warrants exercised for purchase of 731,871 shares of common stock 7,319 4,210,937 Issuance of 262,446 shares of common stock in connection with the acquisition of PACE 2,624 3,158,237 Issuance of 3,928,572 shares of common stock in connection with the acquisition of Drake 39,286 49,460,714 Issuance of 2,850,000 shares of common stock, net of offering costs of $3,367,266 28,500 44,104,234 Foreign currency translation adjustment Unrealized gain (loss) on available-for-sale securities Net income for 1995 3,571,331 ---------- -------------- --------------- Balance at December 31, 1995 223,442 139,785,773 (2,925,642) Options and warrants exercised for purchase of 661,700 shares of common stock, including income tax benefit of $1,887,006 6,617 6,991,426 Issuance of 824,000 shares of common stock in connection with the investment in Jostens Learning Corporation 8,240 21,209,760 Issuance of 116,605 shares of common stock in connection with other acquisitions 1,166 27,225 (319,811) Exercise of underwriter's overallotment option to purchase 33,750 shares of common stock in connection with 1995 public stock offering 337 532,913 Foreign currency translation adjustment Unrealized gain (loss) on available-for-sale securities Net income for 1996 14,796,321 ---------- -------------- --------------- Balance at December 31, 1996 239,802 168,547,097 11,550,868 Options and warrants exercised for purchase of 1,137,245 shares of common stock, including income tax benefit of $8,155,946 11,356 13,108,119 Issuance of 357,143 shares of common stock in connection with contingent consideration related to the acquisition of Drake 3,571 8,139,285 Issuance of 714,884 shares of common stock in connection with the acquisition of WSI 7,149 15,312,982 Issuance of 269,118 shares of common stock to Sylvan Learning Foundation as charitable contribution 2,691 6,538,309 Issuance of 205,882 shares of common stock to IT Training Marketing Company as marketing expense 2,059 6,997,941 Issuance of 176,470 shares of common stock to SLC National Advertising Fund, Inc. as advertising expense 1,765 4,998,235 Issuance of 2,062,292 shares of common stock for cash - net of offering costs of $3,645,455 20,623 73,669,872 Capital contribution by former shareholders of Educational Inroads 2,810,930 Distributions to former shareholders of Educational Inroads (1,332,864) Issuance of 62,562 shares of common stock in connection with other acquisitions 627 718,070 Stock options to purchase 211,000 shares of common stock granted to non-employees 550,000 Foreign currency translation adjustment Unrealized gain (loss) on available-for-sale securities Net income for 1997 29,433,999 ---------- -------------- --------------- Balance at December 31, 1997 $ 289,643 $ 301,390,840 $ 39,652,003 ---------- -------------- --------------- UNREALIZED FOREIGN HOLDING CURRENCY TOTAL GAINS / TRANSLATION STOCKHOLDERS' (LOSSES) ADJUSTMENTS EQUITY ------------- -------------- ---------------- Balance at January 1, 1995 $ (19,846) $ - $ 32,480,545 Options and warrants exercised for purchase of 731,871 shares of common stock 4,218,256 Issuance of 262,446 shares of common stock in connection with the acquisition of PACE 3,160,861 Issuance of 3,928,572 shares of common stock in connection with the acquisition of Drake 49,500,000 Issuance of 2,850,000 shares of common stock, net of offering costs of $3,367,266 44,132,734 Foreign currency translation adjustment 70,000 70,000 Unrealized gain (loss) on available-for-sale securities 14,409 14,409 Net income for 1995 3,571,331 ------------- -------------- ---------------- Balance at December 31, 1995 (5,437) 70,000 137,148,136 Options and warrants exercised for purchase of 661,700 shares of common stock, including income tax benefit of $1,887,006 6,998,043 Issuance of 824,000 shares of common stock in connection with the investment in Jostens Learning Corporation 21,218,000 Issuance of 116,605 shares of common stock in connection with other acquisitions (291,420) Exercise of underwriter's overallotment option to purchase 33,750 shares of common stock in connection with 1995 public stock offering 533,250 Foreign currency translation adjustment (74,131) (74,131) Unrealized gain (loss) on available-for-sale securities (5,606) (5,606) Net income for 1996 14,796,321 ------------- -------------- ---------------- Balance at December 31, 1996 (11,043) (4,131) 180,322,593 Options and warrants exercised for purchase of 1,137,245 shares of common stock, including income tax benefit of $8,155,946 13,119,475 Issuance of 357,143 shares of common stock in connection with contingent consideration related to the acquisition of Drake 8,142,856 Issuance of 714,884 shares of common stock in connection with the acquisition of WSI 15,320,131 Issuance of 269,118 shares of common stock to Sylvan Learning Foundation as charitable contribution 6,541,000 Issuance of 205,882 shares of common stock to IT Training Marketing Company as marketing expense 7,000,000 Issuance of 176,470 shares of common stock to SLC National Advertising Fund, Inc. as advertising expense 5,000,000 Issuance of 2,062,292 shares of common stock for cash - net of offering costs of $3,645,455 73,690,495 Capital contribution by former shareholders of Educational Inroads 2,810,930 Distributions to former shareholders of Educational Inroads (1,332,864) Issuance of 62,562 shares of common stock in connection with other acquisitions 718,697 Stock options to purchase 211,000 shares of common stock granted to non-employees 550,000 Foreign currency translation adjustment (957,475) (957,475) Unrealized gain (loss) on available-for-sale securities 11,043 11,043 Net income for 1997 29,433,999 ------------- -------------- ---------------- Balance at December 31, 1997 $ - $ (961,606) $ 340,370,880 ------------- -------------- ----------------
See accompanying notes. 33
SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, ------------------------------------------------------ 1995 1996 1997 ------------------------------------------------------ OPERATING ACTIVITIES Net income $ 3,571,331 $ 14,796,321 $ 29,433,999 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation 4,112,535 5,986,025 8,167,567 Amortization 4,323,351 7,478,485 10,051,655 Non-cash marketing and advertising expense - - 11,500,000 Interest imputed on purchase of Drake 1,125,000 - - Loss on impairment of assets 3,315,541 - 4,000,000 Non-cash dividend income - - (2,000,000) Provision for doubtful accounts (42,631) 55,738 540,888 Deferred income taxes (387,313) 2,105,914 1,878,471 Equity in net (income) loss of affiliates (390,692) (363,396) 2,131,240 Non-cash issuance of options to non-employees - - 550,000 Gain on sale of property and equipment - - (651,481) Changes in operating assets and liabilities: Accounts and notes receivable (10,780,236) (10,709,674) (26,417,871) Cost and estimated earnings in excess of billings on uncompleted contracts (1,021,779) (412,910) (136,823) Inventory (1,561,091) (134,483) (300,148) Prepaid expenses and other current assets (1,388,445) (273,711) (593,822) Other assets (109,736) (997,608) (754,990) Accounts payable and accrued expenses (3,132,695) 5,406,434 16,341,179 Billings in excess of costs and estimated earnings on uncompleted contracts (455,600) (233,665) 120,350 Deferred revenue and other long-term liabilities 115,149 922,642 1,679,516 --------------- -------------- --------------- Net cash provided by (used in) operating activities (2,707,311) 23,626,112 55,539,730 --------------- -------------- --------------- INVESTING ACTIVITIES Purchase of available-for-sale securities (91,759,493) (31,261,415) (92,521,520) Proceeds from sale of available-for-sale securities 66,595,240 45,542,061 26,044,710 Investment in and advances to affiliates 286,872 (3,346,069) (9,260,478) Increase in other investments - (2,329,874) (4,136,250) Purchase of property and equipment (6,148,998) (13,580,617) (28,659,848) Proceeds from sale of property and equipment - - 1,905,481 Purchase of contract rights - (4,890,576) - Purchase of Drake Prometric, L. P., including direct costs of acquisition, net of cash received (16,979,737) - - Purchase of Wall Street Institute, including direct costs of acquisition, net of cash received - 2,012,565 (4,670,565) Cash paid for other acquired businesses, net of cash received 182,411 - (1,726,012) Expenditures for deferred contract costs and other assets (801,586) (6,941,769) (1,443,058) --------------- -------------- --------------- Net cash used in investing activities (48,625,291) (14,795,694) (114,467,540) --------------- -------------- --------------- FINANCING ACTIVITIES Payments on loans from stockholders of acquired companies (630,533) (37,604) (492,887) Proceeds from exercise of options and warrants 4,218,256 5,111,037 4,963,529 Proceeds from issuance of common stock 44,132,734 533,250 73,690,495 Proceeds from issuance of long-term debt 346,195 154,414 - Payments on long-term debt and capital lease obligations (2,867,459) (2,609,866) (5,323,852) Proceeds from bank lines of credit 4,600,000 200,000 13,575,297 Payments on bank lines of credit - (3,812,069) (14,575,297) --------------- -------------- --------------- Net cash provided by (used in) financing activities 49,799,193 (460,838) 71,837,285 --------------- -------------- --------------- Effects of exchange rate changes on cash 70,000 (74,131) (957,475) --------------- -------------- --------------- Net increase (decrease) in cash and cash equivalents (1,463,409) 8,295,449 11,952,000 Cash and cash equivalents at beginning of period 4,366,066 2,902,657 11,198,106 --------------- -------------- --------------- Cash and cash equivalents at end of period $ 2,902,657 $ 11,198,106 $ 23,150,106 =============== ============== ===============
See accompanying notes. 34 SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION AND DESCRIPTION OF BUSINESS Sylvan Learning Systems, Inc. and subsidiaries (the Company) is an international provider of educational and testing services. The Company conducts operations in three separate business segments - core educational services, testing services, and contract educational services. The core educational services segment designs and delivers individualized tutorial services to school-age children and adults through a network of 670 franchised and Company-owned Sylvan Learning Centers in operation in 49 states, five Canadian provinces, Hong Kong, Guam and South Korea. The Company's testing segment ("Sylvan Prometric") administers computer-based tests for major corporations, professional associations and governmental agencies through a network of certification centers which are located throughout the world. This segment also includes the operations of Wall Street Institute, a European-based franchisor and operator of learning centers that teach the English language through a combination of computer-based and live instruction. The contract educational services segment provides educational programs to employees of large corporations and to public and non-public school districts through contracts funded by federal Title I and state-based programs. The consolidated financial statements include the accounts of Sylvan Learning Systems, Inc. and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. Investments in affiliates owned more than 20%, but not in excess of 50%, and corporate joint ventures are reported using the equity method. The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect reported amounts and related disclosures. Actual results could differ from those estimates. As discussed in Note 3, On May 30, 1997, the Company consummated its acquisition by merger of all of the outstanding stock of I-R, Inc. and Independent Child Study Teams, Inc. (collectively, "Educational Inroads"). The acquisition has been accounted for as a pooling-of-interests and accordingly, the Company's financial statements have been restated to include the results of Educational Inroads for all periods presented. 2. ACCOUNTING POLICIES Cash Equivalents The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. 35 SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2. ACCOUNTING POLICIES (CONTINUED) Investments Available-for-sale securities are carried at fair value, with the unrealized gains and losses, net of tax, reported in a separate component of stockholders' equity. The amortized cost of debt securities in this category is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in investment income. Realized gains and losses and declines in value judged to be other than temporary on available-for-sale securities are included in investment income. The cost of securities sold is based on the specific identification method. Interest and dividends on securities classified as available-for-sale are included in investment income. Inventory Inventory, consisting primarily of computer software and educational, instructional, and marketing materials and supplies, is stated at the lower of cost (first-in, first-out) or market value. Property and Equipment Property and equipment is stated at cost. Depreciation is determined using the straight-line method over the estimated useful lives of the assets. Intangible Assets Goodwill consists of the cost in excess of fair value of the net assets of entities acquired in purchase transactions, and is amortized on a straight-line basis, over the estimated future periods to be benefited, which range from 10 to 25 years. At December 31, 1996 and 1997, accumulated amortization of goodwill was $4,803,586 and $8,723,689, respectively. Contract rights consist of the allocated cost of acquiring computer-based testing contracts in business combinations accounted for as purchases. Contract rights are being amortized on a straight-line basis, over the term of the related contract, which range from nine months to 10 years. At December 31, 1996 and 1997, accumulated amortization of contract rights was $5,193,199 and $6,898,966, respectively. 36 SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2. ACCOUNTING POLICIES (CONTINUED) Deferred Contract Costs Deferred contract costs include costs incurred to develop computer-based tests under contractual arrangements with customers. Under these arrangements, the Company incurs certain costs related to the development of new computer-based tests on behalf of the customer in return for the right to deliver the computer- based tests and collect a testing fee from either the candidate or the sponsoring organization. These costs are capitalized and amortized over the shorter of the estimated utility period of the test or the contractual period for delivery of the test. Deferred contract costs also include payments of approximately $10,400,000 made to non-affiliated computer-based testing centers that have entered into three- year contracts with the Company to deliver information technology computer-based certification tests. In accordance with the terms of these contracts, the independent testing centers have received an advance payment and will receive no additional fees upon delivery of the computer-based certification tests. These costs are being amortized over the contractual term of three years. Impairment of Long-Lived Assets Long-lived assets, including intangible assets, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. If an impairment indicator is present, the Company evaluates whether an impairment exists on the basis of undiscounted expected future cash flows from operations for the remaining amortization period. If an impairment exists, the asset is reduced by the estimated shortfall of discounted cash flows. Revenue Recognition Franchise sales fees relate to single-center and area franchise sales. Revenue related to these sales is recognized when all material services or conditions relating to the sales have been substantially performed or satisfied by the Company. For single-center franchise sales, the criteria for substantial performance include: (1) receipt of an executed franchise license agreement, (2) receipt of full payment of the franchise fee, (3) completion of requisite training by the franchisee or center director, and (4) completion of site selection assistance and site approval. Area franchise sales generally transfer to the licensee the right to develop and operate centers in a specified territory, primarily in a foreign country, and the Company's future obligations are insignificant. Area franchise fees are recognized upon the signing of the license agreement and the determination that (1) all material services or conditions relating to the sale have been satisfied and the fee is non- refundable, (2) a minimum payment of 50% of the fee is required within 90 days of the date of the agreement, and (3) the Company has the ability to estimate the collectability of any unpaid 37 SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2. ACCOUNTING POLICIES (CONTINUED) amounts. Franchise sales fees not meeting the recognition criteria are recorded as deferred revenue if not refundable, or deposits from franchisees if refundable. Commissions paid on sales of franchises are recorded as a current asset until the corresponding revenue is recognized. Fixed price contracts with school districts receiving funds under the federal Title I program and state-based programs are accounted for using the percentage- of-completion method. Income is recognized based on the percentage of contract completion determined by the total expenses incurred to date as a percentage of total estimated expenses at the completion of the contract. Total contract income is estimated as contract revenue less total estimated costs considering the most recent cost information. Revenues from cost-plus-fee contracts are recognized on the basis of costs incurred during the period plus the fee earned. Franchise royalties are reported as revenue as the royalties are earned and become receivable, unless collection is not reasonably assured. Revenues from educational services are recognized in the period the services are provided. Revenue from the sale of products to franchisees is recognized when shipped. Testing revenues are recognized upon the completion of tests. Stock Options Granted to Employees and Non-Employees The Company records compensation expense for all stock-based compensation plans using the intrinsic value method prescribed by APB Opinion 25, Accounting for Stock Issued to Employees ("APB No. 25"). Under APB No. 25, if the exercise price of the Company's employee stock options equals the estimated fair value of the underlying stock on the date of grant, no compensation expense is generally recognized. Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation ("Statement No. 123") encourages companies to recognize expense for stock-based awards based on their estimated fair value on the date of grant. Statement No. 123 requires disclosure of pro forma income and earnings per share data in the notes to the financial statements if the fair value method is not elected. The Company accounts for its stock-based compensation plans using the intrinsic value method, and supplementally discloses in Note 13 to these financial statements the pro forma information as if the fair value method has been adopted. The Company records compensation expense for all stock options granted to non- employees in an amount equal to the estimated fair value at the date of grant, determined using the Black-Scholes option valuation model. The compensation expense is recognized over the vesting period. 38 SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2. ACCOUNTING POLICIES (CONTINUED) Foreign Currency Translation The financial statements of certain foreign subsidiaries that are measured in local functional currencies have been translated into U.S. dollars using the current rate method. All balance sheet accounts have been translated using the rates of exchange at the balance sheet date. Results of operations have been translated using the average rates prevailing throughout the year. Translation gains or losses resulting from the changes in exchange rates from year to year, are accumulated as a separate component of stockholders' equity. The financial statements of other foreign subsidiaries, primarily those subsidiaries providing services overseas to Educational Testing Services, Inc. ("ETS") (see Note 19), prepare financial statements using the U.S. dollar as the functional currency. The transactions of these subsidiaries that are denominated in foreign currencies have been remeasured in U.S. dollars. Any resulting gain or loss is recorded as an adjustment of the amount due from ETS as the contract with ETS requires ETS to bear the risk of realized translation gains or losses. Pending Adoption of New Accounting Standards In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income ("Statement No. 130"), that establishes standards for the reporting and display of comprehensive income and its components in the Company's general-purpose financial statements. Statement No. 130 only impacts display as opposed to actual amounts recorded. Other comprehensive income includes all non-owner changes in equity that are excluded from net income, such as foreign currency translation adjustments and unrealized gains and losses on the Company's available-for-sale securities. Statement No. 130 is effective for financial statements issued for fiscal years beginning after December 15, 1997. The Company will adopt this standard in 1998. In December, 1997 the Accounting Standards Executive Committee of the AICPA issued a proposed Statement of Position ("SOP"), "Reporting on the Costs of Start-Up Activities." The proposal would be effective for fiscal years beginning after December 15, 1997. The SOP as proposed would require that all costs associated with start-up activities, including one-time activities related to opening a new facility, introducing a new product or service and any organizational costs, be charged to expense as incurred. The Company will record the effect of adopting this SOP as a cumulative effect of a change in accounting principle in the year the SOP is adopted. The Company has concluded, after a preliminary review, that the adoption of the SOP will require a cumulative effect charge of between $4.0 million and $5.0 million. 39 SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2. ACCOUNTING POLICIES (CONTINUED) Reclassifications Certain amounts in the 1995 and 1996 consolidated financial statements have been reclassified to conform with the 1997 presentation. 3. ACQUISITIONS NAI/Block Acquisition Effective December 1, 1997, the Company purchased the assets and liabilities of Block Testing Services L.P. and Block State Testing Services L.P. and also acquired all of the outstanding stock of National Assessment Institute, Inc., (collectively "NAI/Block"), commonly controlled companies engaged in the business of designing, marketing, selling, distributing and administering paper and pencil tests and the licensing of individuals. The acquisition, which will be paid by issuing 642,901 shares of common stock valued at $24.6 million, was accounted for using the purchase method of accounting. The results of operations of NAI/Block for the month of December 1997 are included in the accompanying 1997 consolidated statement of income. Goodwill of $28.9 million related to the acquisition is being amortized over its estimated useful life of 25 years. I-R, Inc. and Independent Child Study Teams, Inc. On May 30, 1997, the Company acquired by merger all of the outstanding stock of I-R, Inc. and Independent Child Study Teams, Inc. (collectively, "Educational Inroads") in exchange for 1,414,000 shares of common stock. I-R, Inc. and Independent Child Study Teams, Inc. were commonly owned by two shareholders. The acquisition was accounted for as a pooling of interests and accordingly, the Company's consolidated financial statements for periods prior to the merger have been restated to include the combined results of operations, financial position and cash flows of Educational Inroads. Educational Inroads provides remedial and special education services to public and non-public school systems, with current contracts in New Jersey, Maryland, Louisiana, Washington, D.C. and other school districts. Combined and separate results of operations of Sylvan and Educational Inroads during the years prior to the merger are as follows: 40 SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 3. ACQUISITIONS (CONTINUED)
Previously Independent Reported by Child Study The Company I-R, Inc. Teams, Inc. Combined ------------ ---------- ----------- ------------ Year ended December 31, 1996 Revenues $157,116,660 $9,825,299 $14,994,002 $181,935,961 Net income $ 14,743,106 $ 31,664 $ 21,551 $ 14,796,321 Earnings per common share - diluted $ 0.64 $0.60 Year ended December 31,1995 Revenues $ 87,990,818 $9,475,103 $13,592,629 $111,058,550 Net income $ 3,547,829 $ 16,882 $ 6,620 $ 3,571,331 Earnings per common share - diluted $ 0.23 $0.21
Wall Street Institute International, B.V. and Affiliates Effective December 1, 1996, the Company acquired substantially all of the operating net assets of Wall Street Institute International, B.V. and its commonly controlled affiliates (collectively, "WSI"). The Company recorded the acquisition using the purchase method of accounting. WSI is a European-based franchisor and operator of learning centers that teach the English language through a combination of computer-based and live instruction. WSI has a network of franchised centers in operation throughout Europe and Latin America. The total purchase price of WSI of $21,071,000 consisted of cash of $4,921,000, 505,364 shares of restricted common stock valued at $9,250,000, 209,520 shares of unrestricted common stock valued at $5,900,000 and $1,000,000 of direct acquisition costs. The restricted stock may not be transferred by the sellers for a period of three years from the date of issuance, unless the Company, in its sole discretion, removes the restriction. Of the 505,364 shares of restricted common stock issued to the sellers, 124,292 shares are held in escrow to indemnify the Company against any subsequent losses resulting from any misrepresentation or breach of certain covenants. The unrestricted common stock held in escrow will be released in varying amounts to the sellers through 2001. Goodwill of $19.9 million is being amortized over its estimated useful life of 25 years. The cash portion of the purchase price was recorded as a current liability at December 31, 1996, and the portion of the purchase price represented by common stock was recorded as a non-current liability 41 SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 3. ACQUISITIONS (CONTINUED) at December 31, 1996. Upon closing of the transaction in January 1997, the Company paid the cash portion of the purchase price to the sellers and recorded the issuance of 714,884 shares of common stock to the sellers as a reduction in the noncurrent liability. The Company on the closing date of the acquisition entered into option agreements to purchase two franchisees of WSI, and granted the owners of these same franchisees put rights that require, in certain circumstances and at the election by the right holders, the Company to purchase the franchisees. At the Company's option it may purchase the two franchisees at any time during the period from September 1, 2001 through September 1, 2005 for an amount equal to seven times the previous fiscal years' earnings before interest and taxes, adjusted for certain defined items. The franchisees may require the Company to purchase substantially all of their net assets during the same four- year period if defined levels of operating results are met or exceeded at the end of the most recently completed fiscal year. The purchase price is payable 10% in cash and 90% in common stock, or at the Company's option, entirely in cash. The PACE Group Effective February 28, 1995, the Company purchased the assets and liabilities of The PACE Group ("PACE"), a provider of educational services to corporations. The initial consideration for the acquisition was 262,446 shares of common stock having an aggregate market value of $3,160,861. The acquisition was accounted for using the purchase method of accounting. Additional contingent consideration is payable in an amount equal to 6.5 times PACE's earnings before interest and income taxes (EBIT) in 1997 as elected by the sellers, determined in accordance with generally accepted accounting principles. EBIT in 1997 was $3,965,758, resulting in additional consideration of $25,777,427 payable in cash of $14,469,000 and the remainder in shares of common stock. The Company has recorded this additional consideration as a liability and increased goodwill, and will amortize that amount over the remaining amortization period of 22 years. Drake Prometric, L.P. Effective September 30, 1995, the Company acquired Drake Prometric, L.P. ("Drake"), a Minneapolis based provider of computer-based certification, licensure and assessment testing programs. As of that date, Drake had a network of 820 testing centers on six continents, 472 of which were located in North America and the remainder in 69 foreign countries. 42 SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 3. ACQUISITIONS (CONTINUED) The Company acquired Drake for an initial purchase price $70.6 million, consisting of $20.0 million in cash and 5,714,286 restricted shares of common stock (the "Initial Shares"). Of the Initial Shares, 1,785,714 shares (the "Revenue Escrow Shares") were placed in escrow and will be released to the sellers to the extent that certain revenue targets relating to portions of the combined computer-based testing business are achieved from 1996 through 1998. The sellers may receive up to an additional $40.0 million (payable 12.5% in cash and the balance in either cash or restricted shares of common stock, at the Company's option) to the extent other revenue targets relating to portions of the combined computer-based testing business are achieved in 1998 or 1999 (with the measuring year selected by the sellers). The acquisition was accounted for using the purchase method of accounting. Approximately $4.8 million of contract rights and $69.8 million of goodwill were recorded. The contract rights are being amortized over their respective terms, and no term exceeds five years. Goodwill is being amortized over 25 years, its estimated useful life. The Company will record the contingent consideration consisting of the 1,785,714 Revenue Escrow Shares and the additional contingent payment of up to $40.0 million when the contingencies are resolved and the additional consideration is payable. Based on testing revenues earned by the Company in 1996 and 1997, 60% of the Revenue Escrow Shares (1,071,429 shares) have been earned through December 31, 1997. As of December 31, 1997, an additional $28.2 million of goodwill which relates to the earned shares was recorded which will be amortized over the remaining estimated useful life. The 714,286 Revenue Escrow Shares earned in 1997 will be released to the sellers in 1998. Remedial Education and Diagnostic Services, Inc. and READS, Inc. On February 17, 1995, the Company acquired by merger all of the outstanding stock of Remedial Education and Diagnostic Services, Inc. and READS, Inc. (collectively, "READS") in exchange for 525,108 shares of common stock. The acquisition was accounted for as a pooling of interests and accordingly, the Company's financial statements for periods prior to the merger have been restated to include the results of operations, financial position and cash flows of READS. READS is based in Philadelphia, Pennsylvania and provides remedial and education services, psychological, diagnostic and counseling services, career awareness training, and a variety of consulting services. Services are delivered under contracts with school districts, county-wide educational agencies and municipalities in the eastern United States. 43 SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 4. AVAILABLE-FOR-SALE SECURITIES The following is a summary of available-for-sale securities (cost approximates fair value):
December 31, ------------------------ 1996 1997 ----------- ----------- Municipal securities funds $3,646,361 $ 8,200,000 Cash reserve fund -- 38,221,248 U.S. Treasury bills and notes 3,002,398 -- Municipal bonds 9,800,000 36,504,321 ----------- ----------- $16,448,759 $82,925,569 =========== ===========
The Company has not had any significant realized or unrealized gains or losses on its investments during the periods presented. As of December 31, 1997, the Company has approximately $50.5 million of investments that mature within one year, $4.9 million of investments that mature between one and five years, $6.7 million of investments that mature between six and 20 years and $20.8 million of investments that mature beyond 20 years. These investments are classified as current as the Company views its available-for-sale securities as available for use in its current operations. 5. ACQUISITION OF CONTRACT RIGHTS In 1996, the Company acquired the rights to provide computer-based tests on behalf of the National Association of Securities Dealers, Inc. ("the NASD") for a period of ten years. As part of the agreement, the Company assumed certain lease obligations and acquired the fixed assets of approximately 50 testing centers previously operated by the NASD. The Company paid the NASD $5,114,673, of which $4,871,832 related to contract rights and $242,841 related to fixed assets. In 1997, the Company incurred an additional $1,243,691 of costs related to the acquisition of contract rights from the NASD. The contract rights, are being amortized over the contract life of ten years on a straight-line basis. 44 SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 6. INVESTMENTS Investments in Affiliates At December 31, 1997 and 1996, the Company's investments in and advances to affiliates consists primarily of its 10% voting interest in Caliber Learning Network, Inc. ("Caliber"), including related loans. Caliber is a corporate joint venture with MCI Communications Corp. formed for the purpose of providing adults throughout the United States with university-quality continuing education using multimedia technology. The Company's investment in and advances to Caliber consisted of the following at December 31:
1996 1997 ------------------- -------------------- Invested capital $1,300,000 $ 3,935,642 Loans and related interest 1,212,800 3,361,674 Amounts due for management fee 480,000 2,880,500 ---------- ----------- 2,992,800 10,177,816 Allocable share of losses from inception (141,837) (1,500,842) ---------- ----------- $2,850,963 $ 8,676,974 ========== ===========
Since its inception in 1996, Caliber relied almost entirely on the Company's resources, systems, and personnel for administrative, management, accounting and financial functions. In consideration for these services, the Company charged Caliber $2,880,500, which is unpaid at December 31, 1997. This amount will begin to accrue interest effective January 1, 1999 at the prime rate plus 1%, and is payable in 48 equal monthly installments of principal and interest also beginning January 1, 1999. If Caliber completes an initial public offering of its common stock, all amounts are immediately due and payable. Caliber has agreed to pay an annual management fee of $2.0 million in 1998 and 1999, due in equal quarterly installments. The Company has loaned to Caliber certain amounts under a line of credit that bears interest at 1% above the prime rate as published by a defined commercial bank. All amounts borrowed under the line of credit are due at the earliest of the closing of an initial public offering of Caliber's common stock, or December 31, 2000. During 1997, the Company assigned the leases for 32 testing centers to Caliber for the use by Caliber in its operations. Upon assignment of the centers, Caliber assumed the revenue stream from the ongoing testing operations and paid the Company a fee of $4.0 million to manage the continuing testing operations. 45 SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 6. INVESTMENTS (CONTINUED) The Company also maintains investments in other affiliates totaling $3,044,639 and $3,786,755 at December 31, 1996 and 1997, respectively. The Company's allocable share of earnings (losses) related to these investments for the years ended December 31, 1996 and 1997 was $505,233 and $(772,235), respectively. Other Investments Other investments consist of non-marketable investments in common and preferred stocks of private companies in which the Company does not exercise significant influence. These investments are carried at the lower of cost or estimated net realizable value. At December 31, 1996 and 1997, other investments consist primarily of a non- voting convertible preferred stock investment in JLC Learning Corporation ("JLC"), a company that develops educational software products. The preferred stock requires the payment of cumulative dividends in the annual amount of $2 million for two years totaling $4 million, which may be paid in additional shares of preferred stock. At December 31, 1996 and 1997, the Company's investment in JLC was $21.9 million and $24.0 million, respectively. During 1996 and 1997, the Company recorded dividend income from this investment in the amount of $333,333 and $2,000,000, respectively, paid in the form of additional preferred stock. The Company also maintains other investments not readily marketable totaling $0.3 million and $4.0 at December 31, 1996 and 1997, respectively. 7. BANK LINES OF CREDIT The Company has entered into a loan agreement with a bank, (hereinafter, "the credit line") that provides an unsecured revolving line of credit. The credit line allows the Company to borrow a maximum of $15.0 million through the expiration date of May 31, 1998, at which time the total outstanding principal balance can be converted into a term loan, at the option of the Company. The term loan would be repaid over 24 months from the time of issuance. The credit line and the term loan both bear interest at a floating rate equal to the 30 day London Interbank Offered Rate ("LIBOR") plus 1.15% per annum (6.96% at December 31, 1997). No amounts on the line of credit were outstanding at December 31, 1996 or December 31, 1997. 46 SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 8. LONG-TERM DEBT Long-term debt consists of the following:
December 31, ------------------------- 1996 1997 ---------- ---------- Note payable to a bank, bearing interest at 1.10% over the LIBOR (6.63% at December 31, 1996). The loan was repaid in its entirety in 1997. $2,320,000 $ -- Other notes payable bearing interest at rates ranging from 8% to 14%. 3,032,298 930,231 ---------- ---------- 5,352,298 930,231 Less: current portion of long-term debt 3,182,197 930,231 ---------- ---------- Total long-term debt $2,170,101 $ -- ========== ==========
47 SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 9. DUE TO SHAREHOLDERS OF ACQUIRED COMPANIES Due to shareholders of acquired companies consists of the following (see also Note 3)
December 31, -------------------------------------------------- 1996 1997 -------------------- ---------------------- Amounts payable to former owners of NAI/Block, payable in 642,901 shares of common stock in January 1998 $ - $ 25,000,000 Amounts payable to former shareholders of Educational Inroads 3,232,884 - Amounts payable to former shareholders of WSI in cash 4,920,565 262,285 Amounts payable to former shareholders of WSI, payable in 714,884 shares of common stock in January 1997 15,150,115 - Amounts payable to former shareholders of PACE in cash - 13,531,910 Amounts payable to former shareholders of PACE, payable in common stock in April 1998 - 11,308,427 Amounts payable to former shareholders of Drake in common stock (1996 - 357,143 shares; 1997 - 714,286 shares) 8,142,856 20,057,151 -------------------- ---------------------- 31,446,420 70,159,773 Less: current portion (4,920,565) (13,794,195) -------------------- ---------------------- $26,525,855 $ 56,365,578 ==================== ======================
10. LEASES The Company conducts all of its operations from leased facilities. These facilities include the Company's corporate headquarters and other office locations, warehouse space, certain testing sites, and Company-owned learning centers. The terms of these leases are five years or less, with the exception of the Company's corporate headquarters, which has a lease term of ten years, and generally contain renewal options. The Company also leases certain equipment under operating leases of 36 months or less. Future minimum lease payments at December 31, 1997, by year and in the aggregate, under all non- cancelable operating leases are as follows:
Years ending December 31: 1998 $ 6,831,220 1999 5,976,802 2000 5,316,800 2001 4,515,938 2002 4,357,077 Thereafter 11,195,371 ----------- $38,193,208 ===========
48 SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 10. LEASES (CONTINUED) Rent expense for cancelable and non-cancelable leases was $4.0 million, $6.5 million and $8.2 million for the years ended December 31, 1995, 1996 and 1997, respectively. 11. CONTINGENCIES On November 18, 1996, ACT, Inc. filed suit against the Company alleging that the Company violated federal antitrust laws and committed various state law torts in connection with the operations of its computer-based testing operations and in obtaining a testing services contract from the NASD. The Company believes the grounds of the lawsuit are without merit and intends to defend the lawsuit vigorously. Management is unable to predict the ultimate outcome of the lawsuit, but believes that the ultimate resolution of the matter will not have a material effect on consolidated financial position. The Company is subject to other legal actions arising in the ordinary course of its business. In management's opinion, the Company has adequate legal defenses and/or insurance coverage with respect to the eventuality of such actions and does not believe any settlement would materially affect the Company's financial position. 12. FAIR VALUE OF FINANCIAL INSTRUMENTS The fair value of the Company's financial instruments, which consist primarily of cash and cash equivalents, accounts and notes receivable, available-for-sale investments, accounts payable, due to shareholders of acquired companies (cash portion), and short and long-term debt, approximate their carrying amounts reported in the consolidated balance sheets. It was not practical to estimate the fair value of the Company's other investments because of the lack of quoted market prices of the underlying equity securities and the inability to determine fair value without incurring excessive costs. Management does not believe that the value of these investments have been impaired. 49 SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 13. STOCK OPTIONS AND WARRANTS Stock Options The Company has an Employee Stock Option Plan ("the Employee Plan") which provides for the granting of stock options to purchase up to 3,800,000 shares of common stock. All options granted under the Employee Plan vest ratably over a five-year period and expire six years after date of grant. At December 31, 1997, options to purchase 3,753,199 shares of common stock have been granted under the Employee Plan. Under a Management Stock Option Plan ("Management Plan"), the Company has outstanding stock options at December 31, 1997 to purchase 160,850 shares of common stock for $11.25 per share. All outstanding options are fully vested, and expire on December 1, 2001. No additional options may be granted under the Management Plan. In March 1996, the Company established the Senior Management Stock Option Plan ("the Senior Management Plan") to replace the Management Plan. The Senior Management Plan provides for the granting of stock options to purchase up to 2,250,000 shares of common stock. At December 31, 1997, options to purchase 1,035,000 shares of common stock have been granted under the Senior Management Plan. Options granted under this plan expire ten years after the date of grant. Of this amount, options for 165,000 shares became immediately vested, with the balance vesting ratably over three years. In October 1993 the stockholders approved the establishment of the Director Stock Option Plan ("Director Plan") for all non-employee members of the Board of Directors. Under the Director Plan, options to purchase 172,500 shares of common stock may be issued to certain members of the Board of Directors. No individual is eligible to receive more than 33,750 options under this plan and options granted under this plan expire at varying times three months after a director ceases his term on the Board. At December 31, 1997, options to purchase 168,750 shares of common stock have been granted under the Director Plan. During 1997, the Company established the Sylvan Technology Center Stock Option Plan ("the STC Plan") for the franchisee owners of Sylvan Technology Centers. The STC Plan provides for the granting of stock options to purchase up to 300,000 shares of common stock. During 1997, 211,000 options were granted that vest ratably over a three-year period and expire 10 years after the date of grant or on the date of cessation of operations of the center. The fair value of these options, determined using the Black-Scholes option valuation model, was $1,386,000, of which $550,000 of expense was recognized in 1997, with the remainder to be recognized in expense over the next three years as the options vest. 50 SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 13. STOCK OPTIONS AND WARRANTS (CONTINUED) The following table summarizes the stock option activity of the Company.
1995 1996 1997 --------------------------------------------------------------------------------- Weighted Weighted Average Average Options Options Exercise Price Options Exercise Price --------------------------------------------------------------------------------- Outstanding - beginning of year 2,574,731 3,235,151 $ 7.69 4,614,013 $13.06 Granted 919,083 1,847,875 21.92 1,142,402 35.59 Exercised (258,663) (384,563) 10.87 (1,080,542) 4.38 Forfeited - (84,450) 11.24 (52,482) 17.74 --------------------------------------------------------------------------------- Outstanding - end of year 3,235,151 4,614,013 $13.06 4,623,391 $20.63 ================================================================================= Exercisable at end of year 1,495,502 1,792,312 $ 6.67 1,794,118 $12.77 ================================================================================= Weighted-average fair value of options granted during the year $ 8.33 $10.73 ====== ======
Exercise prices for options outstanding as of December 31, 1997 ranged from $5.22 to $43.88 as follows:
WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE EXERCISE REMAINING EXERCISE PRICES OF CONTRACTUAL PRICES OF RANGE OF OPTIONS OPTIONS LIFE OF OPTIONS OPTIONS OPTIONS EXERCISE PRICES OUTSTANDING OUTSTANDING OUTSTANDING EXERCISABLE EXERCISABLE - ------------------------------------------------------------------------------------------------------ $5.22-$9.12 1,032,750 $6.46 2.0 811,095 $6.41 - ------------------------------------------------------------------------------------------------------ $10.17-$17.00 644,034 13.13 3.7 368,902 12.55 - ------------------------------------------------------------------------------------------------------ $20.33-$29.66 2,158,607 23.04 6.7 614,121 21.30 - ------------------------------------------------------------------------------------------------------ $33.53-$43.88 788,000 38.45 5.8 - - - ------------------------------------------------------------------------------------------------------
For the years ended December 31, 1996 and 1997, pro forma net income and earnings per share information required by Statement 123 has been determined as if the Company had accounted for its stock options using the fair value method. The fair value of these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions for 1996 and 1997: risk-free interest rate of 6.00%, dividend yield of 0%, volatility factors of the expected market price of the Company's common stock of .399 and .280, respectively, and an expected life of granted options which varies from zero to five years depending upon the vesting period. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option 51 SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 13. STOCK OPTIONS AND WARRANTS (CONTINUED) valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's stock options have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock options. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting periods. The Company's pro forma information follows:
1995 1996 1997 - --------------------------------------------------------------------------------------------------------------------- Pro forma net income $2,674,761 $11,938,549 $26,006,873 - --------------------------------------------------------------------------------------------------------------------- Pro forma earnings per share: - --------------------------------------------------------------------------------------------------------------------- Basic $0.18 $0.52 $0.97 - --------------------------------------------------------------------------------------------------------------------- Diluted $0.17 $0.49 $0.92 - ---------------------------------------------------------------------------------------------------------------------
The effect of compensation expense from stock options on 1995 pro forma net income reflects only the vesting of 1995 awards. However, 1996 and 1997 pro forma net income reflects additional years of vesting of the prior year awards and the first year of vesting of current year awards. Because the granted stock options vest over periods ranging from zero to five years, not until 2001 is the full effect of recognizing compensation expense for stock options representative of the possible effects on pro forma net income for future years. Stock Warrants In July 1993 warrants to purchase 239,364 shares of common stock for $5.22 per share were issued in connection with a $5.0 million financing. Warrants to purchase 136,728, 54,457 and 4,790 shares of common stock were exercised in 1995, 1996 and 1997, respectively. The remaining 38,601 warrants expire in July 1998. 14. IMPAIRMENT LOSS In September 1995, the Company determined that certain assets of Sylvan Prometric were impaired as a result of the acquisition of Drake. These assets, consisting of computer equipment, software and other assets, were impaired because of dissimilar technical requirements for Drake computer-based tests, or because their use was limited by virtue of the acquisition of similar productive assets from Drake. The amount of the impairment loss was determined by evaluating the likely sales proceeds from the disposition of the assets as compared to their book value. 52 SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 14. IMPAIRMENT LOSS (CONTINUED) In May 1997, the Company determined that certain assets of Sylvan Prometric were impaired as a result of certain strategic changes that were made as a result of pursuing the National Education Corporation ("NEC") acquisition (see Note 15). During and after the acquisition negotiations with NEC, the Company developed certain plans that resulted in required changes in both software systems and hardware currently utilized in Sylvan Prometric's network of centers. The plans continued to be valid for the Company even after the NEC acquisition was terminated. The impaired assets, consisting of computer equipment and software, were impaired as a result of changes in the technical requirements and specifications of certain computer hardware and software. The amount of the impairment loss was determined by evaluating the likely sales proceeds from the disposition of the assets compared to their book value. The Company determined that it was unlikely that the net cash proceeds from the sale of any assets would be significant, and therefore recorded an impairment loss equal to the net book value of the assets of $4.0 million. 15. TERMINATION FEE In March 1997, the Company and NEC executed a definitive agreement pursuant to which the Company was to acquire NEC. In May 1997, NEC accepted the offer of Harcourt General, Inc. to acquire all of the stock of NEC which resulted in the termination of NEC's agreement with the Company and NEC's payment to the Company of the $30.0 million termination fee required by that agreement. The Company also incurred $1.5 million of expenses in connection with the NEC transaction, and reported the net termination fee of $28.5 million in 1997. 16. CONTRIBUTIONS During 1997, the Company made certain cash expenditures and common stock contributions resulting in an aggregate expense to the Company of approximately $21.5 million. The $21.5 million, recorded as operating expenses, was attributable to contributions of (i) $3.0 million in cash and common stock valued at $7.0 million to IT Training Marketing Company, a nonprofit corporation whose sole purpose is to fund promotional and channel support programs for the Sylvan Prometric distribution channel, (ii) common stock valued at $5.0 million to SLC National Advertising Fund, Inc., a nonprofit corporation whose sole purpose is to develop and fund advertising programs for the Sylvan Learning Centers and (iii) common stock valued at $6.5 million to Sylvan Learning Foundation, a nonprofit foundation formed to promote various educational pursuits. 53 SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 17. Income Taxes Significant components of the provision for income taxes are as follows:
Year ended December 31, ------------------------------------ 1995 1996 1997 --------- ---------- ----------- Current: Federal $ 250,334 $4,991,497 $ 8,972,231 Foreign 133,887 372,996 940,670 State 212,251 1,379,593 1,547,450 --------- ---------- ----------- Total current 596,472 6,744,086 11,460,351 Deferred (benefit): Federal (300,168) 1,773,051 3,441,592 Foreign - - 306,446 State (87,145) 332,863 855,611 --------- ---------- ----------- Total deferred (387,313) 2,105,914 4,603,649 --------- ---------- ----------- Total provision $ 209,159 $8,850,000 $16,064,000 ========= ========== ===========
For the years ended December 31, 1996 and 1997, foreign income before income taxes was approximately $2.9 million and $12.6 million, respectively. The Company uses the liability method to account for income taxes. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. 54 SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 17. INCOME TAXES (CONTINUED) Significant components of the Company's deferred tax assets and liabilities are as follows:
Year ended December 31, ------------------------- 1996 1997 ----------- ----------- Deferred tax assets: Net operating loss carryforwards $ 2,277,600 $ 765,153 Loss on impairment of assets 71,601 779,429 Deferred revenue 443,618 629,659 Allowance for doubtful accounts 301,205 548,046 Advertising costs - 5,304,604 Amortization of intangible assets 459,040 642,977 Equity share of losses from affiliates 53,841 827,089 Charitable contribution carryforward 23,746 2,424,881 Tax credit carryforwards 76,544 925,844 Other 168,780 538,509 ----------- ----------- Total deferred tax assets 3,875,975 13,386,191 Deferred tax liabilities: Deferred contract costs 1,746,807 2,066,448 Contract rights 316,619 169,586 Depreciation 684,508 1,470,612 Deferred income - 11,388,000 Accrued receivables 266,432 558,646 Other 302,610 564,818 ----------- ----------- Total deferred tax liabilities 3,316,976 16,218,110 ----------- ----------- Net future income tax benefit (liability) 558,999 (2,831,919) Valuation allowance for net deferred tax assets (2,277,600) (765,153) ----------- ----------- Net deferred tax liabilities $(1,718,601) $(3,597,072) =========== ===========
The net operating loss carryforwards at December 31, 1997 are related to a subsidiary of the Company, and are available only to offset future taxable income of the subsidiary. These net operating loss carryforwards will begin to expire in 2007. 55 SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 17. INCOME TAXES (CONTINUED) The reconciliation of the reported income tax expense to the amount that would result by applying the U.S. federal statutory tax rates to income before income taxes is as follows:
Year ended December 31, -------------------------------------- 1995 1996 1997 ----------- ---------- ----------- Tax expense at U.S. statutory rate $ 1,277,000 $8,022,000 $15,469,000 Permanent differences 828,000 813,000 2,120,000 State income tax expense, net of federal tax effect 123,000 1,130,000 1,555,000 Tax effect of foreign income taxed at lower rate (87,000) (704,000) (3,556,000) Change in valuation allowance affecting tax expense (2,026,000) - - Utilized tax credits - (254,000) - Other 94,000 (157,000) 476,000 ----------- ---------- ----------- $ 209,000 $8,850,000 $16,064,000 =========== ========== ===========
18. EARNINGS PER SHARE In 1997, the Financial Accounting Standards Board issued Statement No. 128, Earnings Per Share ("Statement No. 128"). Statement No. 128 replaced the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options, warrants and convertible securities. Diluted earnings per share is very similar to the previously reported fully-diluted earnings per share. Earnings per share amounts for all periods have been presented, and where appropriate, restated, to conform to the Statement No. 128 requirements. The following table summarizes the computations of basic and diluted earnings per share: 56 SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 18. EARNINGS PER SHARE (CONTINUED)
Year ended December 31, ------------------------------------- 1995 1996 1997 ----------- ----------- ----------- Numerator used in basic and diluted earnings per common share: Net income $ 3,571,331 $14,796,321 $29,433,999 =========== =========== =========== Denominator: Denominator for basic earnings per common share weighted average shares 15,132,007 23,028,816 26,885,860 Effect of dilutive securities: Employee stock options 1,851,103 1,379,485 1,233,256 Common stock contingently issuable 95,693 178,176 418,878 ----------- ----------- ----------- Total dilutive potential common shares 1,946,796 1,557,661 1,652,134 ----------- ----------- ----------- Denominator for diluted earnings per common share weighted average shares and assumed conversions 17,078,803 24,586,477 28,537,994 =========== =========== =========== Earnings per common share, basic $ 0.24 $ 0.64 $ 1.09 Earnings per common share, diluted $ 0.21 $ 0.60 $ 1.03
The Company as of December 31, 1997 has reserved 6,019,179 shares of common stock for future issuance upon the exercise of all outstanding stock purchase warrants, the exercise of all outstanding stock options and the issuance of shares of common stock in connection with purchase business combinations. 19. MAJOR CUSTOMERS AND CONCENTRATION OF CREDIT RISK In 1997, the Company extended its agreement with Educational Testing Services ("ETS") to be the exclusive commercial provider of ETS domestic computer-based tests through the year 2006. The contract to provide international computer- based tests runs through the year 2004. The international testing contract with ETS stipulates that the Company will be compensated for its services for a fee equal to approved costs plus 10 percent, and the company recognizes revenues accordingly. Operating costs under the contract will be paid at cost plus 10 percent on a monthly basis by ETS. Start-up costs will be paid ratably over a period not to exceed 10 years. Total revenues from ETS represented approximately 16.2%, 10.8% and 17.5% of consolidated revenues 57 SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 19. MAJOR CUSTOMERS AND CONCENTRATION OF CREDIT RISK (CONTINUED) for the years ended December 31, 1995, 1996 and 1997, respectively. The testing business acquired from Drake in September 1995 is highly concentrated with two customers. These customers contributed approximately 23% and 16% to consolidated revenues for the years ended December 31, 1996 and 1997, respectively. The Company expects the contracts with these two customers to be renewed at the expiration date of the current contracts. The failure of these contracts to be renewed under similar terms would have a detrimental effect on future operating results and significantly impair the Company's ability to recover the remaining goodwill balance of approximately $91.6 million related to the acquisition of Drake. Financial instruments which potentially subject the Company to credit risk are investments in available-for-sale securities, accounts receivable and notes receivable. The Company maintains an allowance for losses on receivables based on the collectibility of all amounts owed. The Company generally does not require collateral for trade receivables. Notes receivable are generally collateralized by assets of the debtors. At December 31, 1997, the Company does not have any significant concentrations of credit risk. 20. DEFINED CONTRIBUTION RETIREMENT PLAN The Company sponsors a defined contribution retirement plan under section 401(k) of the Internal Revenue Code. The provisions of this plan allow for voluntary employee contributions, subject to certain annual limitations, and discretionary Company contributions which are allocated to eligible participants based upon compensation. All employees are eligible after meeting certain service requirements. The Company made a discretionary contribution to this plan in 1997 of $248,000. 21. BUSINESS AND GEOGRAPHIC SEGMENT INFORMATION In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related Information ("Statement 131"). Statement 131 supercedes Financial Accounting Standards Board Statement No. 14, Financial Reporting for Segments of a Business Enterprise ("Statement 14"), and establishes new standards for the way that public enterprises report selected information about operating segments in annual and interim financial statements. It also established standards for related disclosures about products and services, geographical areas, and major customers. Statement 131 is effective for financial statements issued for fiscal years beginning after December 31, 1997. The Company has elected to adopt this statement in 1997, and accordingly, the disclosures for all periods have been presented, and where appropriate, restated to conform to the Statement 131 requirements. 58 SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 21. BUSINESS AND GEOGRAPHIC SEGMENT INFORMATION (CONTINUED) Description of Services From Which Each Reportable Segment Derives its Revenues The Company provides lifelong educational services through three distinct operating segments. The Sylvan Learning Centers division provides personalized instructional services to students of all ages and skill levels, through its network of franchised and Company-owned learning centers located in 49 states, five Canadian provinces, Hong Kong, Guam and South Korea. The Sylvan Contract Educational Services division provides educational services and professional development to children and adults through contracts with school systems and other organizations. These services to children are delivered at over 500 schools and in the case of its professional development services for adults, at the contracting parties' facilities. The Sylvan Prometric division delivers computer-based testing for academic admissions and professional certification programs through a network of computer testing centers located throughout the world, and includes the operations of Wall Street Institute, a European-based franchisor and operator of learning centers for English language instruction that will administer certain computer-based testing programs throughout Europe and Latin America. Measurement of Segment Profit or Loss and Segment Assets The Company evaluates performance and allocates resources based on operating income before corporate general and administrative expenses and income taxes. The accounting policies used by the reportable segments are the same as those used by the Company as described in Note 2 to the consolidated financial statements. There are no significant intercompany sales or transfers. Factors Management Uses to Identify the Company's Reportable Segments The Company's reportable segments are business units that offer distinct services. The segments are managed separately as they have different customer bases and delivery channels. The following table sets forth information on the Company's reportable segments:
Year Ended December 31, 1995 ------------------------------------------------------------------------ Contract Learning Centers Educational Services Sylvan Prometric --------------------------- -------------------------- ---------------- Revenues $26,063,191 $50,429,662 $ 34,565,697 Depreciation and amortization 895,430 1,584,352 5,601,471 Loss on impairment of assets - - 3,315,541 Segment profit 7,387,957 2,745,082 901,873 Segment assets 12,863,792 26,568,393 98,200,486
59 SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 21. BUSINESS AND GEOGRAPHIC SEGMENT INFORMATION (CONTINUED)
Year Ended December 31, 1996 ------------------------------------------------------------------------- Contract Learning Centers Educational Services Sylvan Prometric --------------------------- -------------------------- ---------------- Revenues $36,799,287 $58,185,985 $ 86,950,689 Depreciation and amortization 945,968 1,939,778 9,911,562 Segment profit 11,242,406 4,812,800 15,432,208 Segment assets 13,967,337 27,495,706 153,657,895 Year Ended December 31, 1997 ------------------------------------------------------------------------- Contract Learning Centers Educational Services Sylvan Prometric --------------------------- -------------------------- ---------------- Revenues $44,289,019 $66,582,280 $135,340,434 Depreciation and amortization 672,831 1,613,686 14,115,516 Loss on impairment of assets - - 4,000,000 Unusual Items - contribution to marketing fund - - 10,000,000 Significant non-cash charges (advertising) 5,000,000 - - Segment profit 7,580,158 10,525,659 17,484,961 Segment assets 21,843,781 57,064,257 252,724,879
The following tables reconcile the reported information on segment profit and assets to income before income taxes and total assets reported in the statements of income and balance sheets, respectively, for the years ended December 31, 1995, 1996 and 1997:
1995 1996 1997 ------------ ------------ ------------- Operating Profit: Total profit for reportable segments $11,034,912 $31,487,414 $ 35,590,778 Corporate general and administrative expense (6,205,480) (8,755,406) (20,467,883) Other income (expense), net of direct costs (1,048,942) 914,313 30,375,104 ----------- ----------- ------------ Income before income taxes $ 3,780,490 $23,646,321 $ 45,497,999 =========== =========== ============
60 SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 21. BUSINESS AND GEOGRAPHIC SEGMENT INFORMATION (CONTINUED)
1995 1996 1997 ------------ ------------ ------------ Assets: Segment assets $137,632,671 $195,120,938 $331,632,917 Cash and available for sale securities - corporate 33,637,176 27,381,251 86,630,693 Deferred tax asset 1,271,925 619,553 3,737,831 Property, plant and equipment - Corporate 1,007,488 5,249,080 6,809,758 Investments in and advances to affiliates 182,320 5,895,602 12,463,729 Other investments 338,681 22,219,888 28,017,457 Other non-segment assets - 3,103,209 4,223,179 ------------ ------------ ------------ Total assets $174,070,261 $259,589,521 $473,515,564 ============ ============ ============
Included in corporate general and administrative expense for the year ended December 31, 1997 was a contribution of the Company's common stock valued at $6.5 million as discussed in Note 16 to these financial statements. Depreciation expense in the amounts of $0.4 million, $0.7 million and $1.8 million were charged to corporate departments during the years ended December 31, 1995, 1996 and 1997, respectively. Enterprise-Wide Disclosures - Information on Geographic Areas Year Ended December 31, 1995 ------------------------------ Revenues Long-lived Assets United States $100,373,442 $ 99,099,102 Foreign countries - total 10,685,108 5,608,754 ------------ ------------ Consolidated total $111,058,550 $104,707,856 ============ ============ Year Ended December 31, 1996 ------------------------------ Revenues Long-lived Assets United States $152,912,824 $128,218,844 Foreign countries - total 29,023,137 23,743,870 ------------ ------------ Consolidated total $181,935,961 $151,962,714 ============ ================= 61 SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 21. BUSINESS AND GEOGRAPHIC SEGMENT INFORMATION (CONTINUED) Year Ended December 31, 1997 ---------------------------------- Revenues Long-lived Assets United States $188,796,500 $213,901,811 Foreign countries - total 57,415,233 29,325,319 ------------ ------------ Consolidated total $246,211,733 $243,227,130 ============ ============ Revenues from individual foreign countries did not exceed 10% of consolidated revenues in any of the years presented. Long-lived assets domiciled in individual foreign countries did not exceed 10% of consolidated long-lived assets in any of the years presented. Note 19 to the financial statements contains information about major customers of the Company. 22. SUPPLEMENTAL CASH FLOW INFORMATION Interest payments were $2.4 million, $1.1 million and $0.5 million for the years ended December 31, 1995, 1996 and 1997, respectively. The 1995 amount includes imputed interest payments of $1.1 million related to the acquisition of Drake. Income tax payments were $1.8 million, $4.0 million and $2.3 million for the years ended December 31, 1995, 1996, and 1997, respectively. 62 SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 23. QUARTERLY FINANCIAL DATA (UNAUDITED)
Quarter ended --------------------------------------------------- March 31, June 30, September 30, December 31, 1997 1997 1997 1997 --------- -------- ------------- ------------ (Amounts in thousands, except per share data) Operating revenues $51,944 $ 57,596 $58,464 $78,210 Operating expenses 46,591 71,844 46,677 60,978 Loss on impairment of assets -- 4,000 -- -- ------- -------- ------- ------- Operating income (loss) 5,353 (18,248) 10,787 17,232 Non-operating items, net 352 28,899 793 330 ------- -------- ------- ------- Income before income taxes 5,705 10,651 11,580 17,562 Income taxes (2,258) (3,957) (4,053) (5,796) ------- -------- ------- ------- Net income $ 3,447 $ 6,694 $ 7,527 $11,766 ======= ======== ======= ======= Net income per common share: Basic $ 0.14 $ 0.26 $ 0.27 $ 0.41 ======= ======== ======= ======= Diluted $ 0.13 $ 0.25 $ 0.26 $ 0.38 ======= ======== ======= ======= Weighted average shares outstanding: Basic 25,379 25,499 27,746 28,956 ======= ======== ======= ======= Diluted 27,251 27,109 29,255 31,345 ======= ======== ======= =======
During the second quarter of 1997, the Company recognized an impairment loss of $4.0 million, income from a termination fee of $28.5 million and recorded expense related to contributions which totaled $21.5 million. These transactions are described in Notes 14, 15 and 16, respectively. The net effect of the above non-recurring items was an increase in pre-tax income of $3.0 million and net income of $1.9 million, or $.07 per diluted share. Diluted earnings per common share for the year ended December 31, 1997 is $1.03. The total diluted earnings per common share derived from the addition of the quarterly amounts in 1997 is $1.02. This difference is caused by differences in the estimated effect of contingently issuable shares related to the acquisition of PACE in the quarterly periods as compared to the annual period. 63 EX-23.01 2 EXHIBIT 23.01 Exhibit 23.01 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the incorporation by reference in the following Registration Statements of our report dated February 25, 1998, with respect to the consolidated financial statements of Sylvan Learning Systems, Inc. included in the Annual Report (Form 10-K) for the year ended December 31, 1997. Registration Statements on Form S-3 Registration Number Date Filed - -------------------------------------- 33-92014 May 8, 1995 33-92852 May 30, 1995 333-1674 February 26, 1996 333-16111 November 14, 1996 333-21261 February 6, 1997 333-26633 May 7, 1997 333-31273 July 15, 1997 333-39535 November 5, 1997 333-43355 December 29, 1997 333-46747 February 23, 1998 Registration Statements on Form S-8 Registration Name Number Date Filed - ------------------------------------------------------------------------- 1987-1991 Employee Stock Option Plan 33-77384 April 6, 1994 1993 Director Stock Option Plan 33-77386 April 6, 1994 1993 Employee Stock Option Plan 33-77390 April 6, 1994 1993 Management Stock Option Plan 33-77388 April 6, 1994 1997 Employee Stock Purchase Plan 333-21963 February 18, 1997 /s/ ERNST & YOUNG LLP Baltimore, Maryland March 27, 1998 EX-23.02 3 EXHIBIT 23.02 Exhibit 23.2 INDEPENDENT AUDITOR'S CONSENT We consent to the incorporation by reference in the following Registration Statements of our reports dated March 14, 1997, with respect to the financial statements of Independent Child Study Teams, Inc. and I-R, Inc. included in the Annual Report (Form 10-K) for the year ended December 31, 1997. Registration Statements of Form S-3 Registration Number Date Filed - -------------------------------------------------- 33-92014 May 8, 1995 33-92852 May 30, 1995 333-1674 February 26, 1996 333-16111 November 14, 1996 333-21261 February 6, 1997 333-26633 May 7, 1997 333-31273 July 15, 1997 333-39535 November 5, 1997 333-43355 December 29, 1997 333-46747 February 23, 1998 Registration Statements on Form S-8 Registration Name Number Date Filed - -------------------------------------------------------------------------------- 1987-1991 Employee Stock Option Plan 33-77384 April 6, 1994 1993 Director Stock Option Plan 33-77386 April 6, 1994 1993 Employee Stock Option Plan 33-77390 April 6, 1994 1993 Management Stock Option Plan 33-77388 April 6, 1994 1997 Employee Stock Option Plan 333-21963 February 18, 1997 /s/ Deloitte & Touche LLP Parsippany, New Jersey March 30, 1998 EX-27.1 4 EXHIBIT 27.1
5 1,000 YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 23,150 82,926 70,030 1,755 4,778 186,541 63,031 18,725 473,516 68,567 0 0 0 290 340,081 473,516 0 246,212 0 231,089 0 0 526 45,498 16,064 0 0 0 0 29,434 1.09 1.03
EX-27.2 5 EXHIBIT 27.2
5 1,000 YEAR YEAR DEC-31-1996 DEC-31-1995 JAN-01-1996 JAN-01-1995 DEC-31-1996 DEC-31-1995 11,198 2,903 16,449 30,735 43,004 28,434 1,379 1,466 4,470 3,743 77,486 68,175 43,496 28,924 15,578 9,707 259,590 174,070 47,883 28,768 0 0 0 0 0 0 240 223 180,083 136,925 259,590 174,070 0 0 181,936 111,059 0 0 159,204 106,229 0 0 0 0 1,071 2,397 23,646 3,780 8,850 209 0 0 0 0 0 0 0 0 14,796 3,571 0.64 0.24 0.60 0.21
EX-27.3 6 EXHIBIT 27.3
5 1,000 3-MOS 3-MOS DEC-31-1997 DEC-31-1996 JAN-01-1997 JAN-01-1996 MAR-31-1997 MAR-31-1996 12,789 4,272 10,730 22,725 45,678 36,405 1,339 1,469 4,441 3,832 76,922 69,881 46,005 30,491 17,438 10,983 260,380 174,200 36,694 25,301 0 0 0 0 0 0 250 226 201,630 140,980 260,380 174,200 0 0 51,944 41,506 0 0 46,591 38,492 0 0 0 0 209 264 5,705 3,248 2,258 1,469 0 0 0 0 0 0 0 0 3,447 1,779 0.14 0.08 0.13 0.07
EX-27.4 7 EXHIBIT 27.4
5 1,000 3-MOS 3-MOS DEC-31-1997 DEC-31-1996 APR-01-1997 APR-01-1996 JUN-30-1997 JUN-30-1996 29,883 7,315 10,081 18,572 46,608 36,281 1,510 1,529 4,985 3,858 92,944 68,753 42,755 31,663 14,485 12,022 278,829 183,200 37,575 29,121 0 0 0 0 0 0 259 228 232,991 146,753 278,829 183,200 0 0 57,597 47,212 0 0 75,844 42,628 0 0 0 0 231 185 10,652 4,906 3,957 1,874 0 0 0 0 0 0 0 0 6,695 3,032 0.26 0.13 0.25 0.12
EX-27.5 8 EXHIBIT 27.5
5 1,000 6-MOS 6-MOS DEC-31-1997 DEC-31-1996 JAN-01-1997 JAN-01-1996 JUN-30-1997 JUN-30-1996 29,883 7,315 10,081 18,572 46,608 36,281 1,510 1,529 4,985 3,858 92,944 68,753 42,755 31,663 14,485 12,022 278,829 183,200 37,575 29,121 0 0 0 0 0 0 259 228 232,991 146,753 278,829 183,200 0 0 109,540 88,717 0 0 122,434 81,118 0 0 0 0 413 440 16,357 8,154 6,215 3,343 0 0 0 0 0 0 0 0 10,142 4,811 0.40 0.21 0.38 0.19
EX-27.6 9 EXHIBIT 27.6
5 1,000 3-MOS 3-MOS DEC-31-1997 DEC-31-1996 JUL-01-1997 JUL-01-1996 SEP-30-1997 SEP-30-1996 29,624 8,957 80,523 16,416 53,950 34,681 1,465 1,427 5,786 3,994 172,298 66,864 50,819 33,834 16,145 13,402 368,616 184,324 39,376 27,895 0 0 0 0 0 0 289 228 326,293 149,550 368,616 184,324 0 0 58,464 41,482 0 0 47,677 34,473 0 0 0 0 13 198 11,580 7,239 4,053 2,897 0 0 0 0 0 0 0 0 7,527 4,342 0.27 0.19 0.26 0.17
EX-27.7 10 EXHIBIT 27.7
5 1,000 9-MOS 9-MOS DEC-31-1997 DEC-31-1996 JAN-01-1997 JAN-01-1996 SEP-30-1997 SEP-30-1996 29,624 8,957 80,523 16,416 53,950 34,681 1,465 1,427 5,786 3,994 172,298 66,864 50,819 33,834 16,145 13,402 368,616 184,324 39,376 27,895 0 0 0 0 0 0 289 228 326,293 149,550 368,616 184,324 0 0 168,003 130,196 0 0 170,111 115,589 0 0 0 0 426 637 27,937 15,393 10,268 6,240 0 0 0 0 0 0 0 0 17,669 9,153 0.67 0.40 0.64 0.36
EX-99.01 11 EXHIBIT 99.01 Exhibit 99.01 [LETTERHEAD OF DELOITTE & TOUCHE LLP APPEARS HERE] INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholders of Independent Child Study Teams, Inc. We have audited the balance sheet of Independent Child Study Teams, Inc. as of December 31, 1996, and the related statements of income and retained earnings and cash flows for each of the two years in the period then ended (not presented separately herein). These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Independent Child Study Teams, Inc. at December 31, 1996, and the results of its operations and its cash flows for each of the two years in the period then ended in conformity with generally accepted accounting principles. /s/ Deloitte & Touche LLP March 14, 1997 EX-99.02 12 EXHIBIT 99.02 Exhibit 99.02 [LETTERHEAD OF DELOITTE & TOUCHE LLP APPEARS HERE] INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholders of I-R, Inc. We have audited the balance sheet of I-R, Inc. as of December 31, 1996, and the related statements of income and retained earnings and cash flows for each of the two years in the period then ended (not presented separately herein). These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of I-R Inc. at December 31, 1996, and the results of its operations and its cash flows for each of the two years in the period then ended in conformity with generally accepted accounting principles. /s/ Deloitte & Touche LLP March 14, 1997 - --------------- Deloitte Touche Tohmatsu International - --------------- -----END PRIVACY-ENHANCED MESSAGE-----